September 2, 2014 / 3:48 PM / 4 years ago

Scottish independence uncertainty drags sterling to five-month lows

LONDON (Reuters) - Sterling fell to five-month lows and the cost of hedging against sharp currency swings jumped by its greatest rate in three years on Tuesday after a poll showed record support for Scottish independence just two weeks before a referendum.

A pile of one pound coins is seen, in central London June 17, 2008. REUTERS/Toby Melville

The YouGov poll indicated support for the pro-independence “Yes” campaign had risen to 47 percent, a four-point gain since mid-August and up eight points since the start of the month. The lead held by the “No” campaign to reject independence has slumped to 6 points from 22 points at the start of August.

The currency is centre-stage in the heated Scottish referendum debate. Pro-independence leader Alex Salmond says Scotland will share the pound while Westminster has been sceptical about such a deal, leading to some uncertainty about the currency, debt and sharing of North Sea oil revenues.

So far, most investors, including those buying Scotland-based stocks, have been sanguine, factoring in only a slight chance that Scotland will leave the three-century-old union.

But with the latest poll leaving the union on a knife edge, investors are growing jittery. “The currency market is where it will be most acutely felt,” said George Godber, manager of the CF Miton UK Value Opportunities Fund.

Sterling shed 0.7 percent to $1.6492, on track for its biggest daily loss since Aug. 19 and its lowest since March 25. It was also hurt by a strong dollar which got a boost from better-than-expected U.S. data in late afternoon trade.

Even the euro, which has been struggling on expectations of further monetary easing from the European Central Bank, rose 0.6 percent to 79.50 pence.

Traders said sterling is likely to come under more pressure and could lose as much as 5 percent if Scotland leaves the union in a referendum to be held on Sept. 18.

“A Scottish ‘Yes’ to independence poses far more questions than it answers but my best guess is that a ‘Yes’ would trigger a 3-5 percent fall by sterling as an initial reaction,” said Kit Juckes, currency analyst at Societe Generale.

COST OF HEDGING RISES

Britain’s stock market has so far shrugged off the impact of a potential break-up, but analysts warn that a “yes” vote could mean big changes for some Scottish-based companies with a global presence.

Banks such as Royal Bank of Scotland and Lloyds have already said that an independent Scotland could have a significant impact on compliance costs, taxes and credit ratings. Scotland’s asset-management industry would also be exposed.

Independence might also leave a bitter taste for top whisky producer Diageo, as Scotch whisky is Scotland’s second-largest export industry after oil and gas, according to Barclays.

In the currency market, though, the cost of hedging against near term uncertainty jumped. The one-month implied volatility for sterling/dollar was on track for its biggest one-day rise in three years.

The implied volatility rose to around 6.40 percent, its highest level since in five-months, from around 5.1 percent on Monday. One-month risk reversals, a gauge of demand for options on a currency rising or falling, showed their greatest bias for sterling weakness in almost year.

Part of the reason for bearish bets is a slight unwinding of interest rate hike expectations in recent weeks. Data has shown that economic activity is moderating in the United Kingdom and is likely to further cool expectations of rate hikes.

But traders also cited demand for sterling puts - or bets the currency will fall - as the Scottish referendum nears.

Additional reporting by Tricia Wright; Editing by Mark Heinrich

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