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By Jamie McGeever
LONDON, Sept 19 (Reuters) - British financial markets rose and a collective sigh of relief echoed across the investment and business community on Friday after a Scottish vote against independence averted the deep uncertainty a United Kingdom break-up would have unleashed.
Bank shares drove the rally in equities, sterling hit a two-year high against the euro, and currency market volatility - which had reached historically high levels ahead of Thursday’s vote - collapsed.
Royal Bank of Scotland said it had scrapped contingency plans to relocate to England. The cost of insuring against RBS defaulting on its debt dropped to its lowest since May 2008.
Scotland’s rejection of independence ended a fraught few weeks for markets that had seen the value of sterling fall sharply after some polls suggested the 307-year old union was on the brink of splitting.
The vote not only keeps Britain intact but also reduces the likelihood of it leaving the European Union, potentially a much greater risk for markets and something Scottish independence might well have precipitated.
“The imminent threat of change to the union and the ramifications to both equities and currencies is dulled, but ultimately constitutional changes will come, and that in itself will bring a fresh set of challenges,” said Alastair McCaig, analyst at IG in London.
To watch Forex.com's Kathleen Brooks and Mint Partners' Bill Blain discuss the implications for UK markets on Reuters TV, click: reut.rs/1wvsf8P.
The FTSE 100 index of leading shares was up 0.5 percent. RBS rose 2.8 percent, Lloyds gained as much as 2 percent and insurance giant Standard Life was 1.5 percent higher.
Shares of companies with significant exposure to the North Sea oil industry also got a boost. Glasgow-based oil and gas services firm Weir Group was up along with North Sea rig operator Petrofac.
Oil giant Royal Dutch Shell said the rejection of independence “reduces the operating uncertainty for businesses based in Scotland.”
Some of the most dramatic market moves were in the foreign exchange market, particularly in options, which are used by traders and investors to protect themselves against sharp swings in exchange rates. Volatility had risen before Thursday’s referendum to levels not seen since the collapse of Lehman Brothers in 2008 and the unusually uncertain UK general election of 2010.
The cost of insuring against sterling volatility over the next week more than halved to 5.3 percent from a close on Thursday of 11.9 percent. Overnight volatility plunged to 5.5 percent from 23 percent, right back to average levels traded for most of this year.
Sterling itself strengthened, recovering ground lost since the start of the month after one poll put the “Yes” campaign for independence in the lead for the first time in over a year.
The pound hit a two-year high against the euro, with the single currency trading as low as 78.10 pence, and rose above $1.65 against the dollar.
But those gains evaporated and the pound fell 0.5 percent to trade just above $1.63. Major political risks, from the fallout of this vote to next May’s general election, still lie ahead for the pound and other UK assets, analysts said.
Market-based UK interest rates rose, as investors bet there will now be less impediment to the Bank of England (BoE) raising rates as planned, perhaps as early as next year.
The yield on 2-year gilts rose to its highest in over two months at 0.926 percent and the yield on 10-year gilts rose to a six-week high of 2.603 percent before falling back.
“One consequence of a ‘Yes’ vote was that the BoE was expected to go slowly tightening UK rates,” said Alan Wilde, global head of fixed income at Baring Asset Management.
“This outcome may now lead markets to focus back on growth and conclude that the UK economy needs some modest restraint and that the BoE will be ahead of the U.S. raising rates,” he said. (Reporting by Jamie McGeever, Patrick Graham, Sudip Kar-Gupta, Lionel Laurent, David Milliken, Anirban Nag and Ron Bousso; Writing by Jamie McGeever; Editing by Andrew Heavens)