British Pound at risk of 'Fundamental Downshift' in Value Should Scotland Seek 2nd IndyRef

• The Pound to Euro exchange rate today (27-2-16): 1.1740, down 0.54% on the day
• Euro to Pound Sterling exchange rate today: 0.8518
• Pound to Dollar exchange rate today: 1.2474, up 0.08% on the day.

The Pound fell against the majority of its peers at the start of the new week on news the UK Government is now expecting the Scottish government to call for a second referendum on independence. 

The Times reports senior government sources as saying there is serious concern that Nicola Sturgeon will use the start of the Brexit process to demand another vote on the future of the UK and that Whitehall is planning for that event.

“The GBP slides this morning against all major currencies after the Times reported that UK Prime Minister Theresa May is preparing for Scotland to potentially call an independence referendum in March to coincide with triggering of Article 50. The referendum may be allowed but only after the UK leaves the EU,” says Johnny Bo Jakobsen at Nordea Markets.

The prime minister could reject the demand, but such a move would risk causing a constitutional crisis says the report from the Times.

Further, if she agreed, ministers have been warned, she would risk the break-up of the United Kingdom on a “coin toss”.

"The Scottish concerns are, in fact, nothing new. The UK’s decision to quit the European Union had immediately triggered questions regarding Scotland’s future in the United Kingdom. However, the eventuality hasn’t been largely factored in the Pound’s value so far. If Scotland decides to proceed with the second referendum to quit the UK, there would certainly be another fundamental downshift in the Pound’s value, both against the US Dollar and the Euro," says Ipek Ozkardeskaya at London Capital Group.

>> Must Read: Ballooning Budget Deficit Would be an Independent Scotland's Biggest Barrier to EU Membership

Brexit is a perfect excuse to call another referendum on Scotland’s status; and even if the Nationalists lose a second vote rest assured there will be another call for a referendum within a few years.

This could become a cyclical risk to Pound Sterling and we expect the Pound to stay weak in this environment.

"Clearly this is a development that will need to be watched closely as it would significantly increase chances of a UK breakup, particularly in light of Brexit. All of this also has many reconsidering the fact that the Bank of England's next move may not be a hike after all," says a Monday morning client briefing issued by LMAX Exchange Research & Analytics.

However, for Ranko Berich, Head of Market Analysis at Monex Europe, Sterling's declines are nothing to be alarmed by, yet:

"It’s important to put this morning’s Sterling sell-off in context - 0.7% on GBPUSD is hardly seismic. In fact, this is well within the range of one-day volatility we’ve seen recently.

Indeed, at the time of this article's update we have seen Sterling climb back into positive territory agains the Dollar and a haldful of other currencies.

"'Hard Brexit' type stories no longer knock the Pound as much as they did earlier this year and in 2016, suggesting that a good deal of political risk is already in the price. But this morning’s move, however small, suggests that a new Scottish referendum would represent another leg lower for Sterling."

IndyRef 2: A Threat to UK’s Credit Rating

We reported in the wake of the brexit result that another Scottish referendum would put the UK’s credit rating at risk of further downgrades.

1. Rating agencies have identified three broad areas of concern that risk eliciting another UK credit rating downgrade:
   greater likelihood of a Scottish independence;
2. difficulties in financing the current account deficit; and
3. GBP losing its reserve currency status.

“Were these risks to crystallise, and the UK’s credit rating cut again, then we estimate that GBP/USD could fall to 1.20,” says analyst Viraj Patel at Dutch lender ING Bank NV in London. "While a tail risk at this stage - given that those in Westminster are unlikely to cave in to any referendum calls at this stage - such risks are yet to be adequately priced into the currency."

During the course of the last Scottish referendum, the Pound fell steeply before the vote as the polls were too close to call, and even showed the leavers ahead sometimes even though the result was to ‘Remain’.

The sell-off came from uncertainty about the future which lessened investment, including foreign investment and delayed projects with a Scottish association.

It was also thought the UK would suffer from the loss of North Sea Oil reserves.

“If there was another Scottish referendum, the Pound would weaken for the same reasons plus there would also be those created by Brexit. This might well push rating’s agencies into considering a down-grade of the UK’s AA credit rating,” says Patel.

Pound to 'Staircase up' Against the Euro

As mentioned by Monex's Berich, while Sterling is lower we are not seeing any big shifts in value.

In fact, analyst Lucy Lillicrap at AFEX, the foreign exchange brokers based in London, believes GBP/EUR should continue to edge up:

"Values here have pulled back into their previous range for now but not sufficiently to confirm an interim high in place as yet. Any loss of 1.1640/50 secondary support would probably be sufficient to damage the recovery sequence from 1.1300 and provoke another examination of at least 1.1500.

"However GBP prices can otherwise continue to “stair-case” slowly upwards."

Pound to Remain Rangebound Against the US Dollar

Meanwhile against the Dollar, further sideways action is most likely argues Lillicrap:

"The market unable or at least unwilling to stray far from its effective 1.2400 pivot. Additional work remains necessary in any case before any sustainable bottom can be confirmed and for now at least re-emergent strength should continue to prove corrective."