UPDATE 2-Independence with pound would come with strings, Bank of England tells Scotland

Wed Jan 29, 2014 12:46pm EST

By David Milliken

EDINBURGH Jan 29 (Reuters) - Bank of England Governor Mark Carney said on Wednesday that an independent Scotland that keeps the pound would have to give up some national sovereignty or risk the kind of problems exposed by the euro zone crisis.

Carney, speaking in detail for the first time on issues related to September's independence referendum, took care to avoid taking sides in the increasingly heated campaign.

But in a speech to Scottish business leaders, he delivered a sobering message, stressing that a breakaway Scotland and the rest of the United Kingdom would have to secure complex agreements on "tight fiscal rules" and a banking union, or face "clear risks" that could threaten a currency union.

"Those risks have been demonstrated clearly in the euro area over recent years," Carney said. "In short, a durable, successful currency union requires some ceding of national sovereignty."

Both campaigns seized on Carney's speech. The Scottish National Party, which runs Scotland's devolved government, welcomed his comments about the potential benefits of a currency union, which could help investment and lower borrowing costs.

"Mr Carney provides a serious and sensible analysis of how a currency union can work in practice," Scotland's finance secretary John Swinney said.

The British government had a very different take. "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," a spokesman for the Treasury said.

British finance minister George Osborne has said the rest of the United Kingdom - England, Wales and Northern Ireland - might be unwilling to let an independent Scotland keep the pound.

The SNP has responded by suggesting that Scotland might in return refuse to take on its share of the country's 1.2 trillion pounds ($2.0 trillion) of government debt.

In his speech, Carney listed the benefits and potential pitfalls for countries which share the same currency, including the "potentially large costs" of giving up an independent monetary policy and a flexible exchange rate.

CAUTION ON INTEGRATION

The Canadian noted the deep economic integration between Scotland and the rest of the United Kingdom, which buys 70 percent of Scottish exports.

"A word of caution applies here," he said. "The high degree of integration between Scotland and the rest of the UK may in part depend on their being part of the same sovereign nation."

If it wins the Sept. 18 referendum, the creation of a currency union with the rest of the United Kingdom is central to the SNP's vision of an independent Scotland. Alternative options such as joining the euro zone or creating a new currency are seen as more expensive and potentially riskier.

As part of its plan, the SNP proposes the Bank of England should act as lender of last resort for Scottish banks and that an independent Scotland should have a voice within the BoE.

In his speech, Carney said Britain's existing banking system had proved "durable and efficient" and allowed Scotland to have banks that were much bigger than its economy.

"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," Carney said.

Plans for a euro zone banking union aimed at preventing future crises in the bloc were watered down by Germany and others last year and have still to be passed into law by the European Parliament.

Edinburgh-based Royal Bank of Scotland was briefly the world's biggest bank prior to the 2008 financial crisis, with a balance sheet of 1 trillion pounds - bigger than the overall British economy.

The bank still makes losses after being part-nationalised in 2008 and 45 billion pounds ($69 billion) pumped in by the British government to keep it afloat.

With the independence campaign lagging in opinion polls, investors have shown little concern about the chance of Scotland seceding and taking a chunk of North Sea oil and gas with it.

But a poll published on Sunday showed the pro-independence campaign gaining ground, with 37 percent in favour of independence, 44 percent against and 19 percent unsure, according to a survey by polling company ICM.

Last month the British Treasury said it would honour all existing government debt regardless of whether Scots vote for independence, a move aimed at preventing volatility in borrowing costs before the referendum.

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