Is the pound in danger of losing its reserve currency status because of Brexit?

What does this mean? Why would it matter? And is it even true?

Ben Chu
Friday 27 January 2017 17:14
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Need to stash your cash for the tax year? Here's what you need to know
Need to stash your cash for the tax year? Here's what you need to know

Not only has the pound shed more than 15 per cent of its value against the dollar since the Brexit vote last June, but now one City of London analyst has suggested that sterling could be at risk of losing its “reserve currency” status too.

But what does this mean? Why would it matter? And is it even true?

What is a reserve currency?

These are well-established and internationally used national currencies that central banks and governments around the world buy and hold as official “reserves” along with other assets such as gold.

They do this for the purposes of managing their own currencies in times of stress, by selling the reserves at certain times and buying them at others.

The vast majority of global trade is conducted in US dollars – so the dollar is the world’s pre-eminent reserve currency, at around 63 per cent of the total.

But the euro is another, on 20 per cent. Then, some distance later, comes the pound sterling at 4.5 per cent, roughly equal to the Japanese Yen.

According to IMF data the equivalent of $350bn of reserves is held around the world in sterling.

IMF

What’s the benefit?

There will always tend to be pretty robust demand for a reserve currency on the global financial markets (even though the traded value of the currency can fluctuate wildly as we've seen with the pound in recent months).

And to acquire the currency generally means buying a government’s sovereign bonds.

This means the country that has a reserve currency will generally have lower interest rates than they otherwise would. Strong demand for their sovereign bonds pushes up prices meaning yields fall, which pushes down interest rates in the wider domestic economy.

However, some economists point out a potential economic cost. Strong structural demand for a reserve currency could result in a higher than optimum exchange rate for that currency, which hinders its exporters and can stoke problematic economic imbalances.

So who’s saying we may lose it?

Robin Winkler, a London-based strategist at Deutsche Bank, has said that sterling’s status may be sliding.

“To the extent that reserves serve as backstops against currency stress, rather than as sovereign wealth, the pound’s diminishing role in international capital flows post-Brexit should permanently reduce its reserve status,” he wrote in a recent note.

“The pound may offer value, but is increasingly irrelevant.”

Is this really likely to happen?

It will depend on the decisions central banks around the world make.

Mr Winkler has cited data from the IMF which shows that the sterling share of global reserves has fallen slightly in the two quarters to September.

He also says the Chinese central bank is moving out of sterling more rapidly than it moves out of other currencies, as it sells down its massive hoard of reserves in order to stop the value of the renminbi from falling too fast.

Yet there’s no real sign of a collapse in central bank holdings of pounds. And the share of total foreign currency reserves in pounds is actually up on where it was at the beginning of 2014.

The truth is it’s far too early to say – especially as it is still unclear what kind of trade deal the UK will conclude with the EU and what other deals we may strike with other countries.

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