Markets: Central bank reserves come out to play

Europe's central banks will be left with a stonking pounds 144bn in spare foreign exchange reserves once they've stocked up the new European Central Bank's coffers, following the planned introduction of the euro in 1999.

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

Start your day with The Independent, sign up for daily news emails
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Evening Administrator

£8 per hour: Recruitment Genius: This Pension Specialist was established early...

Guru Careers: Executive Assistant / PA

£30 - 35k + Bonus & Benefits: Guru Careers: We are seeking an Executive Assist...

Ashdown Group: Graduate Application Support Analyst

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Reach Volunteering: External Finance Trustee Needed!

Voluntary post, reasonable expenses reimbursed: Reach Volunteering: Would you ...

Day In a Page

War with Isis: Iraq's government fights to win back Tikrit from militants - but then what?

Baghdad fights to win back Tikrit from Isis – but then what?

Patrick Cockburn reports from Kirkuk on a conflict which sectarianism has made intractable
Living with Alzheimer's: What is it really like to be diagnosed with early-onset dementia?

What is it like to live with Alzheimer's?

Depicting early-onset Alzheimer's, the film 'Still Alice' had a profound effect on Joy Watson, who lives with the illness. She tells Kate Hilpern how she's coped with the diagnosis
The Internet of Things: Meet the British salesman who gave real-world items a virtual life

Setting in motion the Internet of Things

British salesman Kevin Ashton gave real-world items a virtual life
Election 2015: Latest polling reveals Tories and Labour on course to win the same number of seats - with the SNP holding the balance of power

Election 2015: A dead heat between Mr Bean and Dick Dastardly!

Lord Ashcroft reveals latest polling – and which character voters associate with each leader
Audiences queue up for 'true stories told live' as cult competition The Moth goes global

Cult competition The Moth goes global

The non-profit 'slam storytelling' competition was founded in 1997 by the novelist George Dawes Green and has seen Malcolm Gladwell, Salman Rushdie and Molly Ringwald all take their turn at the mic
Pakistani women come out fighting: A hard-hitting play focuses on female Muslim boxers

Pakistani women come out fighting

Hard-hitting new play 'No Guts, No Heart, No Glory' focuses on female Muslim boxers
Leonora Carrington transcended her stolid background to become an avant garde star

Surreal deal: Leonora Carrington

The artist transcended her stolid background to become an avant garde star
LGBT History Month: Pupils discuss topics from Sappho to same-sex marriage

Education: LGBT History Month

Pupils have been discussing topics from Sappho to same-sex marriage
11 best gel eyeliners

Go bold this season: 11 best gel eyeliners

Use an ink pot eyeliner to go bold on the eyes with this season's feline flicked winged liner
Cricket World Cup 2015: Tournament runs riot to make the event more hit than miss...

Cricket World Cup runs riot to make the event more hit than miss...

The tournament has reached its halfway mark and scores of 300 and amazing catches abound. One thing never changes, though – everyone loves beating England
Katarina Johnson-Thompson: Heptathlete ready to jump at first major title

Katarina Johnson-Thompson: Ready to jump at first major title

After her 2014 was ruined by injury, 21-year-old Briton is leading pentathlete going into this week’s European Indoors. Now she intends to turn form into gold
Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

Climate change key in Syrian conflict

And it will trigger more war in future
How I outwitted the Gestapo

How I outwitted the Gestapo

My life as a Jew in wartime Berlin
The nation's favourite animal revealed

The nation's favourite animal revealed

Women like cuddly creatures whilst men like creepy-crawlies
Is this the way to get young people to vote?

Getting young people to vote

From #VOTESELFISH to Bite the Ballot