The surprising risks to European markets from Scottish independence

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The British pound saw the heaviest losses in a year as all European equity indices fell as the looming vote for Scottish independence uncovers a hidden counter-trend to European unionization.

The pound fell 1% to $1.62 in afternoon trading in London, its lowest point since July 2013, while also reaching lows against the euro and Japanese yen. Previous calm in the British equity and currency markets has been upset by recent signs that Scotland may vote for independence. Volatility in the British pound has more than doubled to over 9% as traders assess the risk of a breakup of the United Kingdom.

Scotland will vote on independence next week.

Debt Uncertainties

All major political parties have publicly said they would oppose Scottish independence, but more recently Scotland’s First Minister Alex Salmond dismissed other parties’ views on the matter while insisting on a focus on the looming referendum. Specifically, Salmond said that Scotland could refuse to pay its portion of the debt if other major political parties in England and the rest of the UK did not recognize Scotland’s sovereignty.

On the news, all short-term British bonds rallied, with two-year yields dropping 5 basis points. Yields on long-term 30-year bonds rose to 3.12%.

Divided Britain

While most polls indicated voters were not interested in voting for Scottish independence, the most recent YouGov survey conducted for the Sunday Times saw 51% of eligible voters saying that they would vote for an independent Scotland, with no voters falling to 49%.

Responding to the change in sentiment, the Conservative Party, Labor Party, and Liberal Democratic Party of the UK, which currently control most of the British government, agreed that they would offer more control to the Scottish Parliament. Minister Salmond immediately dismissed the offer as a “bribe,” insisting that the vote would continue as scheduled on September 18th.

In recent years, growing political momentum towards an independent Scotland has seen fierce resistance, with investors and politicians pointing to the difficulties of Scotland’s currency and economic viability as an independent nation, suggesting that the country would be heavily dependent on England for infrastructure and trade. Economists remain divided on the matter. Also of concern would be Scotland’s status in the European Union, which some analysts believe would be unclear as the nation did not vote on EU membership and has not passed the tests of membership that all member states are required to pass before joining the union.

European Schisms

While growing divisions on Scottish independence are threatening British currency and equity markets, many investors fear that a successful schism could become a watershed in which smaller regions of large European nations assert their own independence and begin to seek greater authority. The centralization of power, which many see as central to the vision of the European Union, may begin to unravel if the trend continues.

Several European nations have faced the threat of separatists’ movements, which have grown in popularity and political force in recent years as deflation and economic stagnation threaten the European Union as a whole. In Belgium, a movement to dissolve the Belgian state and create Dutch and French speaking independent nations has caused governmental instability in recent years. In 2010, the government fell as tensions on the issue rose.

Similarly, France and Spain have seen increasing political momentum amongst separatists, while the push for independence in Ukraine’s Crimea region exploded into a large conflict between Russia and Western Europe that continues today.