Weighing British Emotion Versus British Reality

Today we separate the emotion behind Scotland's independence vote from the reality underpinning Britain's economy.

Starting with emotion, the British pound has fallen 4.5 percent since June 30, nearly as much as the beleaguered euro.

The British pound has fallen even as economic indicators have improved. Since June 30, the Citigroup U.K. Economic Surprise Index has risen from near a 13-month low to a 3-month high. By contrast, Citigroup's euro zone equivalent still hovers near a 15-month low. In other words, U.K. data has generally surpassed economists' forecast; euro zone data has not.

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Broad measures of growth and employment tell a similar story. Whereas the U.K. economy expanded 1.3 percent in the second quarter, the euro zone stagnated. Six consecutive quarters of growth in Britain have also produced jobs, and a significantly lower unemployment rate.

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Citigroup's head of G10 foreign exchange strategy, Valentin Marinov, writes that "U.K. financial markets are likely to see a short-term reprieve" as focus reverts to the timing of a much-debated interest rate increase by the Bank of England. Removing the overhang of Scottish independence also shifts the focus to longer-term trends, one of which has been particularly consistent: pound appreciation versus the euro.

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By showing the cross rate between the pound and euro, we remove the dollar from the equation, and we can more easily appreciate their direct relationship. While emotion has sent the pound lower in U.S. dollar terms, the pound has maintained its strength against the euro. As Marinov makes clear, resolving the Scottish question lets FX traders get back to reality. We suspect this also implies a stronger pound.

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