Mark Carney has undermined Alex Salmond's plan that an independent Scotland would keep the pound sterling in a currency union, warning that such a model has "clear risks" and "requires some ceding of national sovereignty".
Speaking to business leaders in Edinbugh, the Bank of England governor used a "technocratic" speech to explore the costs and benefits of currency unions, drawing lessons from the eurozone and its recent economic troubles.
He said: "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."
The Bank of England governor insisted that it would be "a matter for the Scottish and UK Parliaments" to decide on the arrangements for a currency union, but warned that the rest of the UK would have to bail out Scotland if its economy started to wane.
He said: "It will be in the interests of other countries in the union to bail out a country in crisis."
After this speech, if Salmond got a Yes vote, he'd certainly be trying to cut Carney out of the negotations, i'd have thought— Tom Clark (@guardian_clark) January 29, 2014
This came as part of Carney's assessment about the "potentially large costs of giving up an independent monetary policy' for countries in a formal currency union arrangement, as the Scottish first minister Alex Salmond seeks for an independent Scotland.
The Scottish government has said that keeping the pound and retaining the Bank of England's services under a currency union was the best option for Scotland and the rest of the UK if Scottish voters vote for independence in September.
The British government has warned that such an agreement would be "unlikely" as the deal would result in Scotland handing over control of its interest rates and borrowing levels to a foreign nation.
Speaking back in September 2012, chancellor George Osborne said the idea was "not credible", saying: "In a world in which a separate, independent Scotland wished to pursue divergent economic policies, what mechanism could there be for the Bank of England to set monetary policy, as it does now, to suit conditions in both Scotland and the rest of the UK?"
Carney said that a currency union could "in the extreme" see a tough economic climate "call into question a country’s membership of the union, creating the possibility of self-fulfilling ‘runs’ on bank", as seen in European countries in recent years like Greece and Italy.
Pro-independence campaigners will take solace in Carney's suggestion that a currency union was still possible, even if with risks.
Although Carney's speech will be interpreted as an attack on pro-independence campaigners' vision of a currency union, critics who have normally questioned the Bank of England governor's independence have praised his speech for staying "out of politics".
Professor Danny Blanchflower, a former member of the Bank of England's Monetary Policy Committee who previously accused Carney of having "compromised" his independence, told HuffPostUK that he welcomed the governor's "sensible" speech.
He said: "I think he has started to learn to stay out of the politics. It is a sensible summary of the literature on currency unions and it is totally appropriate for him to comment on best practice.
"It's hard to see much to disagree with, he needed to stay above the fray and he has by being pretty technical. It is reasonable for the Bank of England to advise on what would be possibilities if Scotland does become independent by working out costs and benefits if various alternatives. He mustn't be George Osborne's mouthpiece and he isn't here."
Martin Beck, UK economist at Capital Economics, told HuffPostUK that Carney forgot to mention that a currency union would expose Scotland "to a lot of fiscal risk".
"Sharing a currency with a country whose government budget was heavily dependent on the oil price and which had a banking sector with assets and liabilities a massive share of its economy. Both those factors would expose Scotland to a lot of fiscal risk."
"But using sterling, implying implicit backing by the Bank of England and the UK, would shift some of that risk to the UK. That would probably mean higher interest rates than otherwise as investors worried about the possibility of having to bail out Scotland."
Mark Carney's speech summed up: If Scotland wants true independence it should abandon the idea of a sterling currency union.— Martin Heneghan (@MartinHeneghan) January 29, 2014
Former chancellor Alistair Darling, head of the Better Together campaign, wrote in a blog on the Huffington Post UK that Carney's "devastating" speech "quietly demolishes Alex Salmond’s claim that Scotland could keep the UK pound after leaving the UK."
- See also: Alistair Darling blogs: "Salmond's Pound Claims Quietly Demolished by Bank of England"
Speaking back in September 2012, chancellor George Osborne said: "In a world in which a separate, independent Scotland wished to pursue divergent economic policies, what mechanism could there be for the Bank of England to set monetary policy, as it does now, to suit conditions in both Scotland and the rest of the UK?
Scottish secretary Alistair Carmichael went further and warned in November that Scotland would be expelled from the sterling currency union if it gains independence and that George Osborne's scepticism about it being allowed back would mean "it is not going to happen".
Carney's appearance up in Scotland comes after he held a meeting with Scottish first minister Alex Salmond.
The Treasury recently pledged to honour all UK debts up to the date of Scotland's independence referendum, in a move to calm anxious investors about the danger that Scotland could refuse pay its debts as a threat in negotiations over a currency union.
In response, Salmond said the UK government had been "hoist by its own petard", adding: “Any debt that has been issued - most of it during Alistair Darling and George Osborne’s Chancellorship - is issued in the title of the UK Government. That’s what they’re having to acknowledge.”
Treasury say "Scotland needs a Plan B" because "in the event of independence, a currency union is highly unlikely to be agreed." #indyref— norman smith (@BBCNormanS) January 29, 2014
A spokesman for Prime Minister David Cameron said: "The issue around currency is an important part of the debate that is currently going on in Scotland. It hardly seems a great surprise at all, on the technical issues, that the governor of the Bank of England might want to set out his views.
"I'm sure the people of Scotland will want to be as well-informed as possible."
Salmond said he was confident that UK ministers would agree to a currency union with an independent Scotland.
He said: "They will agree for two reasons. It is overwhelmingly in the interests not just of Scotland but of the rest of the UK to have Scotland and England sharing the pound.
"Secondly, of course, they will be driven there by the people because that proposition is popular both in Scotland and in England at the present moment.
"So the UK government ministers will do what the people tell them to do, and that is Scotland will keep the pound and England wants us to keep the pound."
The Huffington Post UK has asked the Yes Scotland pro-independence campaigners for comment on Carney's speech.