Pound Surges 1% as Risk of Imminent Scotland Referendum Recedes

The pound strengthened more than 1% against the dollar after the Scottish National Party’s election showing pushed back the risk of a near-term vote on independence, yet traders are bracing for further clashes over the U.K.’s future down the road.

Sterling climbed by the most in almost a month to $1.4134 on Monday, its highest level since February, after the SNP fell one seat short of a parliamentary majority. Strategists from Rabobank International to Credit Agricole SA cite the push for a referendum -- which U.K. Prime Minister Boris Johnson opposes -- as a headwind that could create volatility in the months to come.

“There are a lot of voices in the market that see the lack of a majority for the SNP combined with Johnson’s refusal to hold a referendum as meaning that the risks to the union are a non-issue for the pound,” said Jane Foley, head of foreign-exchange strategy at Rabobank. “I would be more cautious on this.”

Pound Surges 1% as Risk of Imminent Scotland Referendum Recedes

Investors will now be paying attention to how SNP’s leader Nicola Sturgeon pursues the goal of changing Scotland’s constitutional future. Her party boosted its haul to 64 of the 129 seats in the Scottish Parliament and, alongside the Green party that also increased its share, would have enough to form a pro-independence majority. Johnson has said that he would not grant one any time soon, which could lead to a clash in the courts.

Sterling’s rally started during Asia as investors covered short positions and Japanese banks bought the currency, traders said, before extending through London trading. U.K. government bonds led a selloff of haven sovereign assets following the vote. Ten-year yields climbed as much as four basis points to 0.81%.

The U.K. prime minister did strengthen his hand across Northern England, benefiting from the country’s speedy rollout of vaccines. Britain is due to be fully re-opened by June 21 and the corresponding economic boost could be another tailwind for the pound over the coming months. One-month risk reversals, a gauge of market sentiment, show pound traders are at their most bullish versus the dollar since last month.

“’What matters is the U.K. economy, the Bank of England, the dollar and risk markets,” said James Athey, a money manager at Aberdeen Standard Investments. If the dollar suffers in coming months, sterling could rise as high as $1.45, a level last seen in 2016, he said.

For Rabobank’s Foley, continued uncertainties over Scotland’s future could spur volatility in sterling over the next 18 months. Sturgeon has said that if Johnson wants to stop Scottish legislation on a referendum, he would have to go to the Supreme Court to challenge it. A draft Referendum Bill has already been published. While a majority voted to remain in the union in 2014, odds show that a new referendum could be much tighter.

“The pound is not out of the woods just yet,” said Valentin Marinov, head of Group-of-10 foreign-exchange research at Credit Agricole. “The confrontation over independence between Holyrood and Westminster could grow more intense in the wake of the Scottish election and thus add to the downside risks for sterling once again.”

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