Scotland rejects independence - EUR/GBP targets 0.78/0.76

This morning, most of the results from yesterday’s independence referendum in Scotland have been announced. Although three out of the total 32 council areas have not yet declared, it stands firm that the ‘No’ campaign will win the referendum. Currently, the ‘No’ side is on 55% of the vote, and the ‘Yes’ side on 45%. The BBC predicts that the final result will be 55% against 45% in favour of a ‘No’. This was a higher margin for the ‘No’ vote relative to the last few days of the campaign. Given the relative margin of victory, this should remove near-term uncertainty. Further down the road, this does not mark the end of the debate on independence where the focus now shift to the UK’s May 2015 general election.

Markets have reacted positively to the news as they should: the pound trades higher against all major currencies and futures on European equity indices trades higher, notably the future on FTSE 100 (UK equity index) trades higher this morning.

We expect markets to continue to trade with a positive tone today, as a reversal of safe haven flows is likely to support risky assets. UK government bonds are likely to outperform peers as the uncertainty about the future outlook for the UK economy and the risk of an increase in its debt burden has been removed.

In respect of the GBP, we estimate that the risk premium priced into GBP prior to the referendum now has been removed. Hence, we expect EUR/GBP to stabilise around 0.78 in the near term and we still expect EUR/GBP to continue to trade lower in the coming 12 months, primarily driven by divergent monetary policy as we still believe the Bank of England is on a very different path for monetary policy than the ECB. We continue to expect that the Bank of England will begin raising interest rates in January 2015, and we forecast EUR/GBP at 0.78 in 3M, 0.77 in 6M and 0.76 in 12M.