Markets: Central bank reserves come out to play
Sunday 14 September 1997
The central banks of Germany, France, Austria, Belgium, Luxembourg, Ireland, Italy, Spain and the Netherlands will contribute 50bn euros (pounds 31bn) that will get the Euro- pean central bank up and running.
The banks then have a choice. They can either invest the remainder in order to spread their risks and make some money, or pay down debt and help cut their governments' budget deficits. Or they could opt for a combination of the two. But for now, they're not saying which line they'll take.
"We're discussing this intensively, but nothing has been decided," said Jan Paul Korthals Altes, a spokesman for the Dutch central bank. "The formal decision will be taken when the European central bank is founded."
The introduction of the euro will overnight translate what are foreign exchange reserves - held in deutsch-marks, French francs, Belgian guilders and so on - into Europe's newly minted domestic currency, the euro.
The money will still belong to the central banks, although because it's no longer foreign currency, it can't be used to defend the new national currency of Europe. Buying euros with euros serves no purpose if the euro comes under attack from speculators.
Some central banks are already preparing for the change. The Austrian National Bank, for example, has been shifting more of its funds into dollars over the past two years, said the bank's Gerald Husa. "We're not going to say what our portfolio is because we're market participants," he said. "We'll keep our reserves after EMU."
German Bundesbank officials said it would hold its reserves in dollars - as it does now. Other central banks declined to comment on how they plan to deal with reserves after 1999.
Compare those excess funds (equivalent to $230bn) to the $31bn in foreign exchange reserves held by the Federal Reserve for the US, the world's largest economy, and you're looking at a huge amount of cash held by central banks, no longer needing to defend their individual currencies.
"To the extent that reserves are held as a tool for foreign exchange policy, they won't be needed," said Paul Megyessi, senior currency strategist at Deutsche Morgan Grenfell. "Their role will change from conducting monetary policy to investment management.''
As Europe's central banks try to spread their investments in a world which has only three major reserve currencies - the euro, dollar and yen - they're likely to increase their holdings in markets which are less affected than others by shifts in the world's three biggest economies. Australian, British and Canadian securities could, as a result, be direct beneficiaries.
"Domestic currency and deutsch-mark holdings will become euros, and intra- European imports will become domestic trade," said Paul Donovan, senior international economist at UBS. "The banks may start investing in Australian dollars, Swiss francs or Swedish kronor to hedge foreign deals, which will still account for as much as 40 per cent of their trade."
UK bonds and sterling have already seen waves of investment from European central banks, which has contributed to sterling's recent strength against the deutschmark, according to Chris Golden, European EMU strategist at Nomura International. That strength is set to continue, as sterling offers an alternative to deutschmarks and euros. Sterling was recently trading at 2.86 marks.
"Sterling should trade at 2.55 against the mark," said Stewart Cowley, head of fixed income at Hill Samuel Asset Management which manages about pounds 8bn. "Normally it would revert, but because of demands such as central bank diversification needs, it won't."
The yen and dollar securities markets are likely to experience less of a boost because most banks are topped up on their dollar investments. Investment in Japanese markets is made less attractive by the fact that the Bank of Japan and other agencies own most of the bonds. While this supports market liquidity, it means bond yields don't respond to economic fundamentals as other markets do.
Another option is that the banks could pay down national debt, with ECB approval, said Mr Donovan. "The national governments will get their hands on the reserves to pay off old bonds," Mr Donovan added. "Belgium recently revalued its gold reserves and repaid debt to reduce its 130 per cent ratio of debt to gross domestic product."
Such debt repayment probably won't happen for the first few years of EMU because central bankers will want to hang on to their contingency reserves, said Mr Golden. "The central bankers will wait a while before getting rid of their war chests, to make sure there aren't any significant problems with EMU," he said. "The cost of debt is below the return they can get on any investments."
The likely shift to more aggressive investing will be a radical change for the central banks. "They invest in a similar way to catastrophic insurance funds, so it's a sea change for them to start investing like long-term pension funds," he said. "Ultimately, each bank will do its own thing."
Copyright: IOS & Bloomberg
- 1 Hair loss explained: How and why men go bald
- 2 Game of Thrones season 6: Jon Snow theorists believe the Stark may have a twin sister
- 3 Artist takes LSD, draws herself over different stages of the 9-hour trip to show its effects
- 4 A pint of water every day is the key to losing weight, scientists say
- 5 Russia 'accidentally reveals' number of its soldiers killed in eastern Ukraine
Most expensive city to live in for expatriates: Luanda, Angola takes number one spot with Hong Kong and Zurich in top three
Video of Irish 'professional boxer' fighting Istanbul neighbourhood goes viral in Turkey
Irish tourist filmed fighting with shopkeepers in Turkey says they 'messed with the wrong man'
House of Lords: Outcry as donors, fixers and MPs caught up in expenses scandal get peerages
Moody neurotics are more likely to be creative geniuses, study says
Dresden riots: Protesters in Germany attack refugee buses shouting 'foreigners out'
France train shooting: US soldiers speak of the moment they stopped gunman and 'beat him until he was unconscious'
Labour leadership: Jeremy Corbyn accused of 'deluding' young supporters with 'claptrap'
'Women only' train carriages: Jeremy Corbyn unveils radical move to tackle public harassment
Black holes are a passage to another universe, says Stephen Hawking
Iain Duncan Smith calls for urgent ESA overhaul as part of drive to cut down welfare costs
iJobs Money & Business
£13000 - £25000 per annum: Recruitment Genius: Would you like to be part of a ...
£20000 - £25000 per annum + competitive: SThree: Are you passionate about sale...
£25000 per annum + benefits: Ashdown Group: A large financial services company...
£20400 per annum: Ashdown Group: An established and highly reputable organisat...