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Sterling reigns over euro amongst central banks

Central banks view the UK as a safer prospect for investing their currency reserves, despite the uncertainty created by the Brexit vote and Article 50.

That was the key revelation from a survey of reserve managers at 80 central banks, conducted by trade publication Central Banking and HSBC.

According to the FT, concerns over political instability, weak growth and negative interest rates mean reserve managers consider sterling as a long-term, stable alternative to the euro.

This is significant for several reasons. Firstly, reserve managers at 80 central banks are responsible for investments worth more than GBP 5.1 trillion and are tasked with ensuring the value of their domestic currency is maintained. Their decisions will be closely followed by currency traders and investment managers around the world.

Secondly, sterling’s post referendum plunge was widely noted last June. However, it gained against the US dollar during the first quarter of 2017 – the first quarterly gain since June 2015 – and the bullish bets from central banks suggests a further upward correction is on the horizon. 71 per cent of respondents said the attractiveness of the pound was unchanged in the longer term.

The prospect of an imminent resurgence in sterling is backed by analysts at leading investment banks, which predicted an unwinding of near-record bets against sterling if a constructive tone was adopted by the UK and Brussels continued over Brexit negotiations. Japanese bank Nomura in particular, believes the pound is undervalued against the dollar by as much as 25 per cent.

Thirdly, the survey’s findings highlight concerns over the stability of the monetary union, which was identified as the greatest fear for 2017 for reserve managers. Some central banks have reportedly cut their entire exposure to the euro, unprecedented for the world’s second most popular currency, while others have reduced their holdings of investments denominated in euros to the bare minimum.

The survey found that the ECB’s negative interest rate policy was also key factor causing bearishness on the euro. The policy was designed to boost growth across the Eurozone but has impacted profits at banks and financial institutions across the Eurozone.

While these conclusions give reasons for both optimism and trepidation – it’s a matter of perspective, after all – they highlight the fluid and interlinked nature of politics and the currency markets.

More than GBP 3 trillion of currencies are traded every single day around the world, and its impact stretches far beyond the trading floors of the largest international banks.

Currency movements affect everything from individual pensions to the cost of daily household goods, and with politicians on both sides of The Channel spinning dealing with multiple, complex challenges, currency markets will listen intently to their every word.

Brace yourself for a period of excitement, nervousness and volatility over the next 24 months.