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Pound to hold mostly steady vs dollar, unless Scots vote aye
September 4, 2014 / 6:22 AM / 3 years ago

Pound to hold mostly steady vs dollar, unless Scots vote aye

LONDON (Reuters) - Sterling should hold steady against the dollar in the coming year because financial markets have already priced in higher interest rates, according to a Reuters poll, but those forecasts could be scuppered in the still-unlikely event the United Kingdom breaks up.

The pound dropped to a seven-month low against the dollar this week amid concern Scots may yet vote for independence, pulling apart the United Kingdom. A YouGov poll showed the pro-independence camp was just 3 percentage points short of victory in the Sept 18 poll.

Largely taken ahead of the YouGov poll, the Reuters survey of around 60 strategists put sterling at $1.67 in one, three and six months and $1.65 in a year, slightly weaker than in an August poll, but not far from where it is now trading.

A snap survey on Wednesday of 25 regular contributors to the monthly Reuters FX poll suggested that sterling would fall around 3 percent before stabilising if Scotland votes to leave the 307-year old union.

"We would expect considerable volatility in British markets, involving a sell-off in sterling, gilts ... and stocks," wrote Philip Shaw, the chief economist at Investec.

But polls of voters do not point towards that outcome, and several large banks, including some based in the UK, declined to participate in the snap survey, despite being granted anonymity.

"The more divided the UK is, the weaker the pound will be," said Kit Juckes, a currency strategist at Societe Generale, outlining the conventional wisdom when a currency is made to react to political turmoil or major uncertainty.

But Tuesday's fall was the first time the pound - which is being driven mainly by an economic recovery and expectations for interest rates as well as a counterbalance from a resurgent dollar - has shown any major reaction to the debate over Scotland's future.

Indeed, forecasts for the pound have remained mostly steady over the course of the year, reflecting the view that a "Yes" vote in Scotland is seen as a tail risk.

"Sterling's correction to date has far more to do with the UK rate rethink than anything else, and there is very little political risk premium in the pricing - yet," said Juckes.

SWIRLING STERLING

The Bank of England is widely expected to be the first major central bank to raise rates - although not until early next year - but it will be closely followed by the U.S. Federal Reserve, which is forecast to begin tightening policy in the second quarter of 2015.

Britain's economy has staged a rapid recovery in recent quarters and the fastest growth last month in its service industry since November suggested that may continue till through 2014, potentially bringing forward a rise in interest rates.

Speculation rates might rise this year grew in June, when Governor Mark Carney said markets had underpriced the risk of higher borrowing costs. Since then, mixed data and more ambiguous comments from policymakers have tempered some of those expectations.

The U.S. economy is also on a firmer footing but - mindful that any tightening of policy could derail a recovery - the Fed and the BoE are expected to raise rates only gradually.

As markets focus on when the two central banks will tighten policy, they are also debating whether the European Central Bank will move in the opposite direction and loosen policy.

Speculation the ECB is preparing to buy assets blossomed after its president, Mario Draghi, said last month the bank was prepared to respond with all its available tools if inflation - which was just 0.3 percent in August - were to drop further.

Such a move would weaken the euro, and cross rates calculated by Reuters suggested the common currency would be worth 78.9 pence in a month, 77.4p in six and just 76.1p in a year.

In August's poll the euro was pegged at 79.3p in a month, 78.0p in six and 76.9p in 12.

Polling by Swati Chaturvedi and Ishaan Gera; Editing by Larry King

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