Osborne’s Pound in Balance as Scots Weigh Destiny: U.K. Credit

As Chancellor of the Exchequer George Osborne rules out the pound for an independent Scotland, options are narrowing for the nationalists in Edinburgh.

The U.K. wouldn’t enter a currency union should voters in Scotland choose to break away in a Sept. 18 referendum, Osborne said yesterday as he warned that a newly separate state would face higher borrowing costs. One possibility is to retain the pound without an agreement, though that would be too risky, he said. According to the National Institute of Economic and Social Research, Scots would be better off with a new legal tender if they decide to go it alone.

“You can’t force someone to marry you,” Monique Ebell, a research fellow at the institute in London, said after Osborne’s speech in Edinburgh. “Setting up a monetary union that’s successful is not a trivial matter. There isn’t an example of a proper monetary union that you could call successful.”

The currency of what would be Europe’s newest sovereign state is at the heart of the argument over Scottish independence, with the U.K. government using the safety of the pound to persuade Scots to reject independence. Recent opinion polls showed a shift in favor of full autonomy, though with nationalists still short of a victory.

‘Common Sense’

Osborne’s speech in the Scottish capital marked another change of gears in the rhetoric. The U.K. government previously called a currency union “unlikely” rather than an outright “no.” The chancellor said that “if Scotland walks away from the U.K., it walks away from the pound.”

Scottish National Party leader Alex Salmond has called sharing the pound “common sense” because of trade. Salmond and his deputy, Nicola Sturgeon, dismissed Osborne’s comments as “bluster” and bullying.’’ They said it was political posturing before the referendum and the position would change should Scots vote yes. All three main U.K. parties backed Osborne.

“The days of Westminster politicians dictating to Scotland are over,” the BBC reported Salmond as saying.

He said in November when unveiling a 650-page blueprint for independence that he was convinced the U.K. would agree to a currency union. North Sea oil and gas revenue would mean the pound would continue to benefit from Scottish involvement. The document also ruled out joining the euro.

Difficult Debate

“The debate over the use of sterling remains very difficult,” JPMorgan Chase & Co. said in a report on Scottish independence dated yesterday. While its “base case” was for Scotland to vote to remain in the U.K., “the debate over these issues could dominate the campaign,” it said.

The pound rose for a fourth day against the dollar, climbing to the highest level since May 2011. The yield on 10-year U.K. gilts gained 1 basis point to 2.8 percent. An independent Scotland would have to pay between 72 and 165 basis points more than that, Niesr estimates, based on premiums for smaller European countries.

“Currently, Scotland benefits from the whole U.K.’s credibility in the gilt markets,” Osborne said. “Experts already estimate that even a new Scottish state which had accepted its fair share of U.K.’s debt would have to pay an ‘‘independence premium’’ to borrow.”

An independent Scotland would probably decide against using sterling without the agreement of the rest of the U.K. because it wouldn’t have any control over monetary policy, according to Oliver Harvey, a London-based strategist at Deutsche Bank AG, the world’s biggest foreign-exchange trader.

Nordic Model

“That I don’t think would necessarily be the route Scotland would go down,” Harvey said in a telephone interview on Feb. 12. “The more likely alternative if they couldn’t form a currency union with the rest of the U.K. would be something like a currency board where they set the value of the Scottish pound to the English or the British pound.”

That also would raise questions over Scotland’s ability to backstop its financial industry without a lender of last resort such as the Bank of England, according to Ebell at Niesr.

Edinburgh-based Royal Bank of Scotland Group Plc remains the costliest U.K. bank bailout of the 2008 financial crisis. At 45.5 billion pounds ($76 billion), it equals about a third of Scotland’s gross domestic product. The chancellor at the time, the now opposition Labour Party’s Alistair Darling, is fronting the “Better Together” campaign in Scotland.

“If Scotland votes for independence, it could set up its own currency like the Nordic countries,” said Ebell. “They have their own currencies. It’s fine.”

Carney Comments

Bank of England Governor Mark Carney said on a visit to Edinburgh last month that for such a currency union to work and not repeat the mistakes of the euro region, countries must cede some sovereignty over their budgets. There also needs to be checks in place to keep the union together.

When the Czechs and Slovaks separated in 1993, a currency union lasted a matter of weeks. Osborne cited the capital flight from one country to another “in pursuit of the safe haven” as a reason against one with Scotland.

While more money moved initially out of Slovakia and into the Czech Republic, economic data since going their own way tell a different story. Czech economic output per person adjusted for the cost of living has risen 127 percent, according to World Bank data. For Slovaks, who adopted the euro in 2009, it has increased by twice that rate.

Scottish nationalists have said it’s just as much their nation’s pound as the rest of the U.K.’s, though they have no plans to go it alone on the currency and will negotiate should the 1707 Act of Union that formed the U.K. unravel.

That was after Scotland was ruined by a failed project in Panama in the late 17th century. Osborne yesterday warned Scots not to end up there again.

“That is very similar to what Panama does with the U.S. dollar and what Montenegro does with the euro,” Osborne said. “I’m not sure they are the two strongest precedents or countries you’d want to follow.”

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