Governor warning on sterling risks
Sharing sterling between an independent Scotland and the rest of the UK could lead to eurozone-style crises unless firm foundations are put in place, Bank of England governor Mark Carney has said.
An effective union would also force a newly-independent Scotland to hand over some national sovereignty, he said in a speech outlining the potential risks and benefits of currency union.
He intervened less than eight months before people in Scotland decide whether to leave the UK.
"If such deliberations ever were to happen, they would need to consider carefully what the economics of currency unions suggest are the necessary foundations for a durable union, particularly given the clear risks if these foundations are not in place," Mr Carney said at a business lunch in Edinburgh.
"Those risks have been demonstrated clearly in the euro area over recent years, with sovereign debt crises, financial fragmentation and large divergences in economic performance. The euro area is now beginning to rectify its institutional shortcomings, but further, very significant steps must be taken to expand the sharing of risks and pooling of fiscal resources.
"In short, a durable, successful currency union requires some ceding of national sovereignty.
"It is likely that similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the UK."
Despite his conclusion, he made clear that any decision is for voters and parliaments, and that the bank would operate any union to the "best of its ability".
"Any arrangement to retain sterling in an independent Scotland would need to be negotiated between the Westminster and Scottish parliaments," he said.
"The Bank of England would implement whatever monetary arrangements were put in place."
Mr Carney, who became governor last July, focused on the implications of Scottish independence in his speech just hours after his first face-to-face meeting with Scotland's First Minister, Alex Salmond.
The pair met for private talks at Bute House, Mr Salmond's official residence in Edinburgh.
The Scottish Government wants to retain the pound if the country votes for independence, establishing a "sterling zone" with the rest of the UK. Other pro-independence groups, including the Scottish Green Party, argue for a separate currency.
Technical discussions on sharing sterling, which started under Mr Carney's predecessor Sir Mervyn King, are expected to continue.
UK ministers including Chancellor George Osborne have cast doubt on whether the arrangement is possible.
A Treasury spokesman said the Scottish Government needs to come up with a plan B.
"Governor Carney today highlights the principled difficulties of entering a currency union: losing national sovereignty, practical risks of financial instability and having to provide fiscal support to bail out another country," the spokesman said.
"This is why the UK Government have consistently said that, in the event of independence, a currency union is highly unlikely to be agreed. The Scottish Government needs a plan B."
But Scottish Finance Secretary John Swinney said: "Ultimately, as Mr Carney makes clear, a sterling area is a matter for the two governments to agree. Such a shared currency area is the common sense position as it is in the overwhelming economic interests of both Scotland and the rest of the UK.
"An independent Scotland will control 100% of our own revenues, compared to the 7% of our tax base we are currently responsible for under devolution.
"A shared currency will mean an independent Scotland having control of tax policy, employment policy, social security policy, oil and gas revenues, immigration policy and a range of other levers to suit our own circumstances, helping to grow our economy, create jobs and secure a more prosperous and fairer society."
Mr Carney said a currency union's success also rests on a good banking union, a term covering the range of institutions needed to support an efficient financial sector.
These include common supervisory standards, access to central bank liquidity and lender of last resort facilities.
There are difficulties separating those institutions from national fiscal arrangements, he said.
"The existing banking union between Scotland and the rest of the United Kingdom has proved durable and efficient," he said.
"Its foundations include a single prudential supervisor maintaining consistent standards of resilience, a single deposit guarantee scheme backed by the central government, and a common central bank, able to act as lender of last resort across the union, and also backed by the central government.
"These arrangements help ensure that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP.
"The euro area has shown the dangers of not having such arrangements, as well as the difficulties of the necessary pooling of sovereignty to build them."
He compared shared arrangements with flexible exchange rates, weighing up pros and cons.
Sharing a currency can "promote investment" by giving businesses better access to markets, and it can promote integration while easing the flow of technology and ideas, he said.
But it can also amplify fiscal stress and increase risks of financial instability.
Success, or otherwise, hinges on the mobility of labour, capital and goods; institutional structures promoting financial stability; and institutions that "mutualise risks and pool fiscal resources".
Former chancellor Alistair Darling, who leads the Better Together campaign to keep Scotland in the UK, said the speech spells out stark problems.
"As the governor makes clear, in a currency union both sides have to agree to each other's taxes, spending and borrowing. This is what is happening in the eurozone today," he said.
"It is highly unlikely that the people living in the rest of the UK would agree to this. And remember, in a currency union like this, Scotland has 10% of GDP and the rest of the UK would have 90%. It is clear who would call the shots."
Political parties at Holyrood were able to find support in his speech for both sides of the argument.
Kenneth Gibson, the SNP convener of Holyrood's finance committee, said a sterling area is achievable.
"The UK Government has already accepted the common sense position on Westminster's debt, and in light of the governor's speech there is no reason - other than trying to spread uncertainty on behalf of the No campaign - not to take the same sensible approach in relation to currency," he said.
Scottish Labour finance spokesman Iain Gray said: "If Alex Salmond seriously expects people to vote Yes in September, he needs to come up with a Plan B on currency soon."
Scottish Conservative leader Ruth Davidson said: "This is a crushing blow for the SNP's plans to keep the pound, making it even more incredible that they haven't come up with a currency plan B."
Scottish Liberal Democrat leader Willie Rennie said: "A half in, half out version of our current union would offer Scotland the worst of all worlds."
Green co-leader Patrick Harvie said: "I recognise that the SNP's preference is for continued use of sterling but given the likelihood of the Scottish and UK economies diverging we should stand ready to exert full economic independence using our own currency."