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
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
News
Buddy DeFranco
people
Arts and Entertainment
British actor Idris Elba is also a DJ and rapper who played Ibiza last summer
filmIdris Elba responds to James Bond rumours on Twitter
Arts and Entertainment
Lena Headey as Cersei Lannister in Game of Thrones
film
News
i100
Sport
Yaya Sanogo, Mats Hummels, Troy Deeney and Adnan Januzaj
footballMost Premier League sides are after a striker, but here's a full run down of the ins and outs that could happen over the next month
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

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

iJobs Job Widget
iJobs Money & Business

Selby Jennings: VP/SVP Credit Quant- NY- Investment Bank

Not specified: Selby Jennings: VP/SVP Credit Quant Top tier investment bank i...

Selby Jennings: Quantitative Research | Equity | New York

Not specified: Selby Jennings: Quantitative Research | Global Equity | New Yor...

Selby Jennings: SVP Model Validation

Not specified: Selby Jennings: SVP Model Validation This top tiered investment...

Selby Jennings: Oil Operations

Highly Competitive: Selby Jennings: Our client, a leading European Oil trading...

Day In a Page

War with Isis: The West needs more than a White Knight

The West needs more than a White Knight

Despite billions spent on weapons, the US has not been able to counter Isis's gruesome tactics, says Patrick Cockburn
Return to Helmand: Private Davey Graham recalls the day he was shot by the Taliban

'The day I was shot by the Taliban'

Private Davey Graham was shot five times during an ambush in 2007 - it was the first, controversial photograph to show the dangers our soldiers faced in Helmand province
Revealed: the best and worst airlines for delays

Revealed: the best and worst airlines for delays

Many flyers are failing to claim compensation to which they are entitled, a new survey has found
The stories that defined 2014: From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions

The stories that defined 2014

From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions
Stoke-on-Trent becomes first British city to be classified as 'disaster resilient' by the United Nations

Disaster looming? Now you know where to head...

Which British city has become the first to be awarded special 'resilience' status by the UN?
Finally, a diet that works: Californian pastor's wildly popular Daniel Plan has seen his congregation greatly reduced

Finally, a diet that works

Californian pastor's wildly popular Daniel Plan has seen his congregation greatly reduced
Say it with... lyrics: The power of song was never greater, according to our internet searches

Say it with... lyrics

The power of song was never greater, according to our internet searches
Professor Danielle George: On a mission to bring back the art of 'thinkering'

The joys of 'thinkering'

Professor Danielle George on why we have to nurture tomorrow's scientists today
Monique Roffey: The author on father figures, the nation's narcissism and New Year reflections

Monique Roffey interview

The author on father figures, the nation's narcissism and New Year reflections
Introducing my anti-heroes of 2014

Introducing my anti-heroes of 2014

Their outrageousness and originality makes the world a bit more interesting, says Ellen E Jones
DJ Taylor: Good taste? It's all a matter of timing...

Good taste? It's all a matter of timing...

It has been hard to form generally accepted cultural standards since the middle of the 19th century – and the disintegration is only going to accelerate, says DJ Taylor
Olivia Jacobs & Ben Caplan: 'Ben thought the play was called 'Christian Love'. It was 'Christie in Love' - about a necrophiliac serial killer'

How we met

Olivia Jacobs and Ben Caplan
Bill Granger recipes: Our chef's breakfasts will revitalise you in time for the New Year

Bill Granger's healthy breakfasts

Our chef's healthy recipes are perfect if you've overindulged during the festive season
Transfer guide: From Arsenal to West Ham - what does your club need in the January transfer window?

Who does your club need in the transfer window?

Most Premier League sides are after a striker, but here's a full run down of the ins and outs that could happen over the next month
The Last Word: From aliens at FA to yak’s milk in the Tour, here’s to 2015

Michael Calvin's Last Word

From aliens at FA to yak’s milk in the Tour, here’s to 2015