38/99
2 March 1999
QUARTERLY REPORT ON UK OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD: OCTOBER - DECEMBER 1998
The Treasury and the Bank of England published today the Quarterly Report on UK official holdings of foreign currency and gold for the period October to December 1998. The report gives details of the forward foreign exchange position, the currency composition of foreign currency assets, the size and currency composition of foreign currency liabilities for the Exchange Equalisation Account (EEA) and the Bank of England's holdings of foreign currency and gold.
The report shows that the level of the Government's reserves, including the forward book was $36.9 billion at end-December, with no underlying increase on end-September. Net forward holdings of foreign currency were $1.23 billion at end-December.
The level of the Bank of England's holdings of foreign currency and gold was $3.19 billion at end-December. No intervention operations were undertaken during the quarter to end-December with either the Government's reserves or the Bank of England's holdings.
NOTES TO EDITORS
1. Media copies of the quarterly report are available from the Treasury Press Office on 020 7270 5185 or from the Bank of England Press Office on 020 7601 4411.
2. Non-media copies of the report are available from the Treasury Public Enquiry Unit on 020 7270 4558 or from the Bank of England on 020 7601 4878.
3. If you have access to the Internet you can find this information at www.bankofengland.co.uk.
4. The quarterly report covering January - March 1999 will be published on 2 June 1999.
QUARTERLY REPORT ON THE UNITED KINGDOM OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLDOCTOBER DECEMBER 1998
This report contains a commentary on foreign exchange market developments during the three months October December 1998 and details changes in the level and composition of UK official holdings of foreign currency and gold over that period.
I: FOREIGN EXCHANGE MARKET DEVELOPMENTS
Summary
1. The smooth launch of the euro on 31 December 1998 was the major structural event of the quarter. The focus for market developments however was the very large appreciation of the yen. This occurred with almost unparalleled speed, with the US dollar/ yen rate changing by nearly 20% within thirty six hours. Foreign exchange markets continued to be affected by the volatility in emerging markets triggered in the previous quarter by the floating of the Russian rouble and the announcement of a partial moratorium on Russian debt repayments. Sterling and the US dollar depreciated during the quarter as official interest rates were cut in both the UK and the US. Sterling developments
Sterling developments
2. Table A shows that sterling fell by 3«% on a trade-weighted basis against the other major currencies during the fourth quarter. Most of the depreciation occurred during October, against each of the G3 currencies. UK official interest rates
were cut on three separate occasions, by a total of 125 basis points during the period. Expectations of the level of UK interest rates in 1999 also fell. Although official interest rates in the US and Germany were also reduced during the fourth quarter and market expectations of future rates were similarly affected, the movement in UK rates was larger and hence the impact on the exchange rate greater. A technical market issue
may also have been significant. Positions which had been opened to take advantage of the difference between the market ECU and the basket of currencies that underlay the ECU had to be unwound by the year-end because of the impending conversion of ECU into euro. The unwinding of these positions resulted in some selling of sterling towards the end of the year.
Table A: Exchange rates and effective exchange rate indices
| 1998 | 30/9 | 30/10 | 30/11 | 31/12 | % change from 30/9/98 |
| ERI Pound | 103.3 | 100.0 | 100.5 | 99.7 | -3.5 |
| Pound/DM | 2.8407 | 2.7740 | 2.7925 | 2.7731 | -2.4 |
| Pound/$ | 1.6997 | 1.6752 | 1.6513 | 1.6640 | -2.1 |
| $/DM | 1.6713 | 1.6559 | 1.6911 | 1.6665 | -0.3 |
| $/Yen | 136.18 | 116.63 | 122.92 | 112.77 | -17.2 |
| $ ERI* | 109.7 | 104.8 | 107.1 | 103.9 | -5.3 |
| Yen ERI* | 111.3 | 129.6 | 123.9 | 134.5 | 20.8 |
| DM ERI* | 106.0 | 105.3 | 105.3 | 105.1 | -0.8 |
Source: Bank of England
* Average 1990 = 100
International developments
3. The final stages of convergence of the euro-area countries' exchange rates to the pre-announced bilateral parities went smoothly, including a co-ordinated cut in interest rates to 3%. On 31 December, the irrevocable conversion rates of the legacy currencies against the euro were set. The euro's value at its launch was determined to be $1.1668 (0.7055 Pounds).
4. The yen's appreciation against the other major currencies in early October was the other major international development of the quarter. The dollar fell from around ¾132 to an intra-day low of ¾111.5 between 7 and 8 October. One month implied
volatility in the dollar / yen exchange rate surged to an unprecedented level of around 40%. The underlying explanation of the yen's appreciation may be found in fundamental factors such as the widening US current account deficit, falling US interest rates, and increased optimism about the prospects for restructuring of the Japanese banking sector. But the rapidity and extent of the move appears to have reflected illiquid market conditions and the unwinding of short yen positions taken out during the long period of low nominal Japanese interest rates.
II: THE LEVEL AND COMPOSITION OF UK OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD
5. The accompanying tables show the size and composition of the foreign currency and gold holdings of the Exchange Equalisation Account (EEA) and of the Bank of England. Due to differences in accounting methodology that are explained in the footnotes to the
tables, no overall total for the EEA and Bank holdings is shown. EEA Holdings
6. As shown in Table 1, during the quarter to end-December the total of foreign currency and gold reserves in the EEA increased by $ 379 mn. The increase was almost entirely accounted for by the increase in Capital and Other Items totalling $ 378 mn. The most significant factor was the issue of a new Euro Treasury Note. The underlying change in the reserves, that is the change net of Capital and Other items, was nil.
7. During the quarter the UK's reserve tranche position at the International Monetary Fund increased by $ 185 mn to $ 3,646 mn as a result of international financial support operations coordinated by the IMF. The UK contribution to the activation of the IMF's New Arrangements to Borrow (NAB) amounted to a further $ 317 mn.
8. Under EEA accounting methodology the non-US dollar assets of the EEA are translated to US dollars at exchange rates (termed 'parity rates') that are set at the end of March each year and which apply for the subsequent twelve months. The method of calculation of parity rates, and the level of the major rates, is set out in Note 3 to the EEA Tables. If translation to US dollars had been carried out at prevailing market rates, the total of gold and foreign currency reserves in the EEA would have been $40.4 bn at end-December and $ 39.8 bn at end-September compared to $ 36.9 bn and $ 36.6 bn respectively at parity rates.
9. The introduction of the euro required a partial revaluation of the reserves at the end of December. At the introduction of the euro some assets in the currencies that were replaced by the euro ('legacy currencies') were redenominated to euro so that, for example, what was a deutsche mark asset became a euro asset, while others retained their legacy currency denomination. The parity rate established for the ECU at end-March 1998 has been used as the parity rate for the euro and will be until the next general revaluation at the end of March. Assets which continue to be denominated in legacy currencies have been valued by converting the legacy currency amount into a euro amount using the official conversion rates fixed on 31 December 1998 and then applying the euro parity rate. This results in a partial revaluation for all assets denominated in legacy currencies before the introduction of the euro. The product of the legacy currency conversion rates and the euro parity rate differ from the parity rates established for the legacy currencies which were used between end-March 1998 and end-December 1998. After the partial revaluation arising from the euro conversion process, the total of gold and foreign currency reserves in the EEA was $ 36,978 mn, an increase of $ 41 mn.
10. As set out in the Chancellor's letter of 6 May 1997 to the Governor, if the government so instructs then the Bank, acting as its agent, may intervene in the foreign exchange market by buying or selling the government's foreign exchange reserves. If intervention is undertaken, the quarterly reports will provide details of the amount and date of the intervention and an explanation of why it was undertaken. No intervention operations were undertaken during the quarter to end-December.
11. Foreign currency liabilities, which formally are liabilities of the National Loans Fund rather than of the EEA, are set out in Table 2. Footnote 2 to the EEA tables gives more detail on these liabilities.
12. The third reopening of the Government's 4.25% 2001 Euro Note was held in October; h 500 mn was sold at this tender. The total of euro and ECU Notes and bonds outstanding with the public therefore rose from h 8 bn to h 8.5 bn during the quarter. Tenders of euro and ECU Treasury Bills totalling the equivalent of h 1 bn were held each month, comprising the equivalent of h 200 mn of one-month, h 500 mn of three-month and h 300 mn of six-month bills. The total of Bills outstanding with the public was therefore maintained at the equivalent of h 3.5 bn. Repayments of non-marketable debt are shown in footnote 6 to the EEA tables. Bank of England Holdings
13. The Bank of England's holdings of foreign currency and gold during the quarter arose from the following sources:
- foreign currency and gold deposits placed with the Bank by overseas central banks and other customers in the course of their banking relationships with the Bank;
- foreign exchange swaps conducted as part of the Bank's domestic sterling money market operations. These swaps are undertaken as a supplement to the Bank's usual money market techniques to provide sterling liquidity to the market, and are purely technical in nature;
- foreign exchange swaps and asset swaps undertaken to fund the euro balances that the Bank holds as a consequence of the UK's connection to the TARGET payments system.
14. Under the Bank's accounting methodology holdings of foreign currency and gold are translated to US dollars at prevailing market exchange rates. The overall change in the Bank's holdings of foreign currency and gold during the quarter to end-December was an increase of $ 442 mn. The underlying change excludes the change in valuation over the month, changes in holdings arising from changes in foreign currency and gold deposits placed with the Bank by overseas central banks and other customers, changes due to the net effect of foreign exchange and asset swaps conducted in the course of the Bank's money market operations and in connection with TARGET, and other capital items. There was no underlying change during the quarter.
15. The end-December totals shown for the Bank in Table 1 have been revised from those originally published in the regular monthly press release issued on Tuesday 5 January.
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16. As set out in the Chancellor's letter of 6 May 1997 to the Governor, the Bank may also undertake foreign exchange operations to intervene in support of its monetary policy objective. If intervention is undertaken, the quarterly reports will provide details of the amount and date of intervention and an explanation of why it was undertaken. No intervention operations were undertaken during the quarter to end-December.
| TABLE 1: TRANSACTIONS | |||
| EEA | USD mn at Parity Rates | ||
| SPOT | FORWARD | TOTAL | |
| BALANCE AS AT 30 SEPTEMBER | 35,282 | 1,275 | 3,557 |
| PURCHASES (+) / SALES (-) | -148 | -15 | -163 |
| INVESTMENT INCOME | 152 | 12 | 164 |
| CAPITAL AND OTHER ITEMS | 56 | 322 | 378 |
| BALANCE AS AT 31 DECEMBER | 35,343 | 1,594 | 36,937 |
| OVERALL CHANGE | 60 | 319 | 379 |
| UNDERLYING CHANGE | 4 | -4 | 0 |
| EEA POST-EURO CONVERSION | USD mn at (new) Parity Rates | ||
| SPOT | FORWARD | TOTAL | |
| BALANCE AS AT 31 DECEMBER | 35,449 | 1,529 | 36,978 |
| BANK OF ENGLAND | USD mn at Current Rates | ||
| SPOT | FORWARD | TOTAL | |
| BALANCE AS AT 30 SEPTEMBER | 3,766 | -1,017 | 2,749 |
| PURCHASES (+) / SALES (-) | 4,748 | -4,703 | 45 |
| INVESTMENT INCOME | 0 | 0 | |
| CAPITAL AND OTHER ITEMS | 0 | 0 | 379 |
| BALANCE AS AT 31 DECEMBER 397 | 397 | -5,720 | 3,191 |
| 8,911 |
| OVERALL CHANGE | 5,145 | -4,703 | 442 |
| UNDERLYING CHANGE | 0 | 0 | 0 |
| SPOT | FORWARD | TOTAL | |
| BALANCE AS AT 31 DECEMBER | 7,428 | -4,301 | 3,127 |
TABLE 2: BREAKDOWN OF ASSETS AND LIABILITIES AT END DECEMBER 1998
| EEA | USD mn at Parity Rates | |
| ASSETS | LIABILITIES | |
| US DOLLARS | 10,250 | 7,817 |
| EU CURRENCIES | 15,770 | 13,054 |
| YEN | 1,029 | 1 |
| OTHER | 210 | 152 |
| TOTAL CURRENCIES | 27,258 | 21,023 |
| SDR | 444 | 2,556 |
| IMF RESERVE TRANCHE | 3,646 | - |
| IMF GAB | 193 | - |
| IMF NAB | 317 | - |
| GOLD | 5,078 | - |
| TOTAL | 36,937 | 23,579 |
| BANK OF ENGLAND | USD mn at Current Rates | ||
| ASSETS | LIABILITIES | NET ASSETS | |
| US DOLLARS | 1,040 | 1,040 | 0 |
| EU CURRENCIES | 1,158 | 1,107 | 51 |
| YEN | 0 | 0 | 0 |
| OTHER | 0 | 0 | 0 |
| TOTAL CURRENCIES | 2,198 | 2,147 | 51 |
| GOLD | 993 | 993 | 0 |
| TOTAL | 3,191 | 3,140 | 51 |
Notes to the EEA Tables
1. The EEA's foreign exchange reserves are held in assets of high liquidity and credit quality, for the most part government securities issued by the US, EU countries and Japan. In the management of the EEA the Bank of England also makes use of other financial instruments including interest rate and currency swaps, bond and interest rate futures and sale and repurchase agreements.
2. The bulk of the government's foreign currency liabilities consist of marketable international bonds which generally trade as benchmarks in their sector. At end-December these comprised three US dollar bonds (two fixed-rate and one floating-rate) totalling $ 7 bn; a Euro Note, two ECU Notes and an ECU bond totalling h 8.5 bn ($ 10.0 bn equivalent); and h 3.5 bn ($ 4.1 bn equivalent) of Euro Bills. The rest of the liabilities consist of remaining non-marketable long-term debt arising from loans made by the US and Canadian governments during World War II, and liabilities arising from the Exchange Cover Scheme, under which HM Treasury undertakes to sell foreign currency to repay local authority and public corporation borrowing from the European Investment Bank and European Coal and Steel Community. There has been no new non-marketable borrowing since the 1980s, and the debt is being gradually repaid under fixed amortisation schedules.
3. The EEA tables have been compiled according to EEA accounting methodology:
- Transactions are accounted for on a cash basis, ie on settlement.
- Assets are valued on an historic cost basis.
- Liabilities are shown at their nominal value.
- Non-US$ foreign currencies are translated to US$ using the average of the relevant dollar exchange rates in the three months up to the end of March each year or using the actual exchange rates on the last day in March, whichever calculation gives the lower US$ value. The major translation rates ("Parity Rates") set for the year beginning 31 March 1998 are shown below. It should be noted that the official reserves figures in the UK Balance of Payments statistics (The Pink Book) are expressed in sterling, with translations done at current market exchange rates.
| Currency | Parity Rate vs US$1 |
| Sterling | 0.595 |
| Euro | 0.929 |
| Yen | 132.9 |
Gold is valued at the average of the London fixing price for the three months to end-March, less 25%; or at 75% of its final fixing price on the last working day in March, whichever is the lower. The gold price in use during the year beginning 31 March 1998 is US$ 220.66 per troy ounce.
4. Included within liabilities is the UK's allocation of IMF Special Drawing Rights (SDRs). In the event of the winding up of the IMF SDR Department, or in other circumstances, the UK could be obliged to repurchase SDRs to the extent of its allocation. It should be noted that the treatment of the UK SDR allocation in the Pink Book differs. The SDR allocation is shown therein as a memorandum item.
5. Investment income is net income derived from ownership of foreign financial assets, including any capital gain or loss realised on sale. As noted above, income is in general recognised only when it is realised. The exception to this rule in the table is that interest on deposits maturing beyond the quarter date and the accrued interest bought or sold in the forward leg of a repo agreement are shown as forward investment income. As a result of this income recognition policy the published figure may fluctuate considerably from quarter to quarter. It should be noted that this is not the same treatment as in the Pink Book. The underlying change in the spot reserves excludes a number of items, identified as Capital and Other Items, which are included in the overall change:
- Receipts from HMG Euro Treasury Notes issued totalled $ 549 million.
- Revaluation arising from EMI / ECB swap of $ 323 million. Due to the mechanics of the swap this appears as a negative figure in the spot reserves, balanced by a positive entry in the forward book. The final EMI / ECB swap matured at the end of December.
- There were repayments of $155 million of long-term debt arising from loans received from the US and Canadian governments during the Second World War.
- There were repayments of $ 20 million of public sector borrowing for which HMG has provided an exchange rate guarantee under the Exchange Cover Scheme (ECS).
- Receipts from HMG Euro and ECU Treasury Bills issued exceeded repayments on those maturing by $ 6 million.
- There were repayments of $1 million of ECS borrowing which had been assigned to the Government from former public sector bodies.
6. The underlying change is the result of a variety of transactions, both debits and credits, including, for example, transactions for Government departments, transactions with other central banks, and interest receipts and payments. For these reasons, the underlying change should not be taken as an indication of market intervention.
Notes to the Bank of England Tables
1. These tables have been compiled on the basis of the Bank of England's accounting policies. In particular the following should be noted:
- Assets and liabilities in currencies other than US$ are translated to US$ at the exchange rates ruling at the end of the quarter.
- Gold is valued at current market rates on the basis of the London fixing price, without discount.
- Investment income is recognised on an accruals basis, and is displayed here net of interest paid on liabilities. Income accrued in foreign currency that has been exchanged for sterling is excluded from the table.
2. The Bank's foreign currency and gold assets and liabilities are published annually in the Bank's Report and Accounts.
3. The Bank's contribution to the European Monetary Institute (EMI) of ECU 95mn (US$ 112 mn at the end-December exchange rate) was largely funded by a deposit from the EEA of ECU 93mn. This deposit therefore appears both as a foreign currency liability of the Bank and as an asset of the EEA. On 4 January the Bank's contribution to the EMI was repaid net of the Bank's contribution to the European Central Bank (ECB) of h 37mn. The deposit from the EEA matured on 26 January. Data contained in this report and in previous Quarterly Reports is published in The Bank of England's Monetary and Financial Statistics, copies of which may be obtained from the Bank.