Dec. 2 (Bloomberg) -- The proposal by Scottish nationalists to retain the pound should they win independence would be the only practical option for the new country, currency traders say, even as the plan is rejected by the government in London.
Retaining sterling would make sense because of Scotland’s ties to the British economy, according to Deutsche Bank AG and Citigroup Inc. Scottish First Minister Alex Salmond said when unveiling his blueprint for independence last week that keeping the pound, the best-performing major currency over the past six months, is the “common-sense position.”
Sterling is at the center of the debate over plans by Salmond and his semi-autonomous government in Edinburgh to unravel the U.K. after 306 years. Maintaining a currency union after a political divorce would be unlikely, a spokesman for British Prime Minister David Cameron said last week.
“Scotland fits an optimum currency area with the rest of the U.K. very well,” Oliver Harvey, a London-based strategist at Deutsche Bank, the biggest currency trader, said in a Nov. 27 phone interview. “For the pound, Scottish independence is not particularly significant for the rest of the U.K.”
If Scotland were to retain sterling, it would be keeping a currency that has gained 7.3 percent in the past six months against nine developed-nation peers as measured by Bloomberg Correlation-Weighted Indexes, the biggest advance in the group.
The pound traded at $1.6355 as of 4:43 p.m. in New York, after earlier touching $1.6443, the highest level since August 2011. It has strengthened 11 percent since reaching a three-year low in July.
Sterling climbed to a more than 10-month high of 82.53 pence per euro, paring its decline this year to 2 percent. It’s on pace for its first annual loss versus the shared currency since 2008, data compiled by Bloomberg show.
The U.K. government ultimately will agree to an independent Scotland keeping the pound, Salmond said when presenting his 650-page white paper, as a policy document is known in Britain, in Glasgow on Nov. 26. He plans to lead Scotland to independence on March 24, 2016, for the first time since 1707 and after a referendum next September.
Former Chancellor of the Exchequer Alistair Darling, a Labour Party Scot who’s spearheading the anti-independence “Better Together” campaign, said Salmond’s claim to keep sterling was unrealistic.
“The currency isn’t like the CD collection you carve up when you get divorced,” Darling said last week in response to the white paper.
Under a political process known as devolution, the Scottish Parliament has since 1999 controlled health, education, transport and justice, while the U.K. government in London is in charge of the overall economy, defense and foreign policy.
After winning a majority in the legislature in 2011, Salmond and his Scottish National Party put forward plans for a referendum on full independence.
The most recent TNS BMRB poll shows Salmond’s “yes” campaign is trailing those in favor of the status quo by 18 percentage points. While more people are in favor of independence since the white paper was published, bookmakers Ladbrokes Plc and William Hill Plc still put the odds of a nationalist win at 9-2, compared with 1-7 for a “no” vote.
The white paper covers everything from the pound to childcare costs and the removal of nuclear weapons from Scotland. It also includes plans to keep the Bank of England as the lender of last resort and to gain a 90 percent share of North Sea oil and gas reserves.
BOE Governor Mark Carney, who started in his post in July, told reporters in London on Nov. 28 that “there has been an effort to set up a meeting” to discuss a potential currency union with the Scottish nationalists and that “I’m sure it will happen at some point.”
Two-thirds of Scotland’s exports in 2011 went to the rest of the U.K., while Scotland is Britain’s second-largest trading partner, according to the policy document.
“Given the close economic ties between the two and assuming that these ties need not weaken going forward, the potential introduction of a currency union need not affect significantly trade and other flows,” Valentin Marinov, the head of European Group-of-10 currency strategy at Citigroup, the second-largest foreign-exchange trader, said by e-mail Nov. 27.
Citigroup sees the pound advancing to $1.73 and 80 pence per euro by mid-2014, making it more bullish than the median estimates in Bloomberg analyst surveys, which put the U.K. currency at $1.57 and 82 pence.
Sterling has been buoyed as the U.K. avoided a recession earlier this year, with the economy growing at the fastest pace in more than two years in the third quarter. Gross domestic product expanded 0.8 percent in the three months through September, the Office for National Statistics said Nov. 27.
While exports dropped 2.4 percent, business investment increased 1.4 percent. A gauge of factory activity today showed manufacturing expanded more than forecast in November. The improving economic data relieved pressure on the BOE to lower interest rates from a record-low 0.5 percent. Rate cuts tend to weaken a currency.
Salmond also favors maintaining the pound because Scotland and the rest of the U.K. have similar levels of productivity, a key test of an optimal currency area, according to the Scottish government’s guide to independence. Scottish banks already issue their own pound-denominated bank notes.
A U.K. Treasury study in April said a currency union without political integration is unlikely to work well. It would bring a “fundamental asymmetry in the degree of exposure to fiscal and financial risk” between the countries, according to the report. Other options for Scotland include creating its own currency or joining the euro, though it would first need European Union membership.
“It wouldn’t make any sense for Scotland not to have the pound,” said Deutsche Bank’s Harvey. “Its economy is very highly correlated with the rest of the U.K.”
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