QUARTERLY REPORT ON THE UNITED KINGDOM OFFICIAL
HOLDINGS OF FOREIGN CURRENCY AND GOLD
JULY SEPTEMBER 1999
This report contains a short commentary on foreign exchange market
developments during the three months July September 1999 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
1. Sterling appreciated moderately in overall terms over the quarter, principally against the dollar. Overall, the dollar depreciated against the major currencies over the period. The Japanese yen continued to appreciate. The euro fell slightly.
2. Sterling's effective exchange rate rose by 1.1% in Q3. Within
this overall movement, sterling appreciated over the period by 1.2%
against the euro and by 4.4% against the dollar, but depreciated by
8.1% against the yen. The Bank of England's Monetary Policy Committee
raised official UK interest rates by 25 basis points at its meeting
on 8 September.
Table A: Exchange rates & effective exchange rate indices
Source : Bank of England * change in £/euro
3. The US dollar depreciated over Q3, with its effective exchange rate index falling by 5.4%. It depreciated sharply against the yen (by 12.0%) and, to a lesser extent, against other major currencies including the pound (by 4.4%) and the euro (by 3.2%). The dollar's depreciation occurred in spite of monetary policy tightening by the Federal Reserve and a more general rise in the US yield curve through this period. The dollar seemed more sensitive over the period to the performance of the US stock market than it did to changes in the yield curve: falls in the Dow Jones and S&P 500 indices tended to coincide with falls in the dollar.
4. The Japanese yen appreciated against all major currencies during Q3: the yen effective exchange rate index rose by 12.1% over this period. The continued appreciation of the yen reflected the stronger performance of the Japanese economy and upward revisions to forecasts for Japanese growth. In addition, the prospect of stronger economic growth attracted capital inflows into the yen as foreign investors sought to increase their exposure to Japanese assets.
5. In terms of its effective exchange rate index, the euro fell by 0.9% over Q3. It appreciated against the dollar by 3.2%, but depreciated against the yen by 9.2% and against sterling by 1.2%. From a low against the dollar in mid-July, the euro was helped by improving prospects for output growth in the euro area, including forward-looking indicators such as the German IFO survey, and perceptions of a possible rise in euro interest rates.
6. Gold traded in a narrow range between $255 and $260 per ounce for most of the second quarter. However, it rallied strongly, rising from $255 to $270, following the second auction of UK gold held on 21 September (see para 12); and it rallied further following the announcement on 26 September by 15 European central banks (including the Bank of England) that gold sales would be limited to 400 tonnes each year over the next five years, that sales would be co-ordinated and that central banks would not expand their gold lending activity.
II: THE LEVEL AND COMPOSITION OF UK OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD
7. 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. As a result of differences in accounting methodology that are explained in the footnotes to the tables, no overall total for the EEA and Bank holdings is shown.
8. As shown in Table 1, during the quarter to end-September, the total of foreign currency and gold reserves in the EEA fell by $ 2,181mn from the end-June figure of $ 34,831mn to $ 32,650mn. The reduction was more than accounted for by Capital and Other Items totalling $ 2,182mn(1). The underlying change in the reserves, that is the change net of Capital and Other Items, was an increase of $ 2mn. If translation to US dollars had been carried out at prevailing market rates rather than at the parity rates set at end-March, the total of gold and foreign currency reserves in the EEA would have been $ 35.4bn at end-June and $ 34.7bn at end-September. The difference between the total at prevailing market rates and at parity rates is primarily due to the 25% discount applied to the value of gold at end-March in calculating the reserves at parity rate.
9. 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-September.
10. 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.
11. In July, the UK reopened the 2.75% 2002 Euro Note by selling a further 500mn of the issue. The total of Euro and ECU Notes and bonds outstanding with the public therefore rose from 7.5bn to 8bn during the quarter. In addition, 300mn of one-month Euro Treasury Bills were auctioned in each of July and August. These bills were the last to be sold under the Euro Treasury Bill programme. By end-September all Euro Treasury Bills had matured and the Bank of England had fully taken over as issuer of Euro Bills (see paragraph 14). Repayments of non-marketable debt are shown in footnote 6 to the EEA tables.
12. On 7 May, HM Treasury announced a restructuring of the UK's net reserve holdings, which involves a programme of auctions of gold from the EEA. Two of these auctions took place in 1999Q3. Twenty-five tonnes of gold were sold at each. The first auction, held on 6 July, achieved a price of $ 261.20 and was covered 5.2 times; the second auction, which took place on 21 September, achieved a price of $ 255.75 and was covered 8 times. Further details about the programme are available from the Treasury and Bank of England Press Offices and their respective web sites.
Bank of England Holdings
13. The Bank of England's holdings of foreign currency and gold stood at $ 7,536mn at the end of the quarter. These arose from the following operations:
- 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 moneymarket 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 foreign currency-denominated securities, interest rate swaps and asset swaps undertaken to fund and hedge the euro balances that the Bank holds as a consequence of the UK's connection to the TARGET payments system;
- euro balances with other central banks operating the TARGET system. These are very largely off-set by similar balances that the other central banks hold at the Bank and as a result are shown net in the tables below, where they account for $ 124mn at end-September. The gross amount at end-September was $ 44,363mn.
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-September was an increase of $ 3,277mn. However, there was no underlying change during the quarter. The underlying change excludes the change in valuation over the quarter, 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, changes in euro balances with other central banks operating the TARGET system, and other capital items.
15. During the quarter, the Bank of England completed the process, which began in April, of taking over from HM Treasury as the issuer of Euro Bills. 300mn of six-month and 500mn of three-month Bank of England Euro Bills were issued in each of the three months during the quarter, and in addition 200mn of one-month Bills were issued in September. The total nominal amount of Bank of England Euro Bills outstanding with the public therefore rose from 900mn at end-June to 3.5bn at end-September, by which time (with all Euro Treasury Bills having matured) the Bank had taken over fully as issuer of Euro Bills. The proceeds of Bank of England Euro Bills are used by the Bank to finance the provision of intra-day liquidity, on a secured basis, to participants in CHAPS Euro, as part of the arrangements for TARGET.
16. As set out in the Chancellor's letter of 6 May 1997 to the Governor, the Bank may 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-September.
TABLE 1: TRANSACTIONS
EEA USD mn at parity rates
BANK OF ENGLAND USD mn at Current Rates
TABLE 2: BREAKDOWN OF ASSETS AND LIABILITIES AT END SEPTEMBER
EEA USD mn at parity rates
BANK OF ENGLAND USD mn at Current Rates
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-September these comprised three US dollar bonds (two fixed-rate and one floating-rate) totalling $ 7bn; and two Euro Notes, one ECU Note and an ECU bond totalling 8bn ($ 8.5bn equivalent). 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 current 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 1999 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.
- 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 1999 is US$ 209.59 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.
6. 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:
- There were repayments of $ 19mn of public sector borrowing for which HMG has provided an exchange rate guarantee under the Exchange Cover Scheme (ECS);
- Capital repayments of HMG Euro and ECU Treasury Bills maturing exceeded receipts from those issued by $ 2,770mn;
- Receipts from the issue of HMG's 2002 Euro Note totalled $ 527mn.
7. The underlying change also excludes the difference between the valuation of the gold auctioned on 6 July and 21 September at the parity rate of $ 209.59 per troy ounce and the auction allotment prices ($ 261.20 and $ 255.75 per troy ounce, respectively). These amount to $ 79mn in total.
8. 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
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.
The Bank's foreign currency and gold assets and liabilities are published annually in the Bank's Report and Accounts.
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.
1. 1 See Note 6 to the EEA Tables.
3. 2 Includes residual balances denominated in the predecessor currencies of the euro.