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Central banks diversify from dollar - extended

Central banks are increasingly diversifying their reserves, including cutting holdings of dollars, according to a survey sponsored by Royal Bank of Scotland Group Plc, the UK's second-largest bank.

Italy, Russia, Sweden and Switzerland have made „major adjustments” in foreign-exchange holdings favoring the euro and the British pound, according to the poll conducted by Central Banking Publications Ltd. between September and December. China also plans to manage its reserves more actively, the report said. „Central banks are open to saying they've been diversifying to improve returns and reduce exposure to any single currency,” said Sean Callow, senior currency strategist at Westpac Banking Corp. in Singapore. „There's no doubt that when they say 'diversification' they mean selling dollars.” Diversification could make it more difficult for the US to fund its current-account deficit, the broadest measure of trade in goods and services, and cause yields on Treasury bonds to rise. The dollar accounted for 65.6% of the world's currency reserves in the Q3, according to the IMF.

The US current-account deficit widened to a record $225.6 billion in the Q3 of 2006, according to the Commerce Department. When a country runs a deficit in the current account, it relies on overseas investment to offset a shortfall in savings. Net purchases of US stocks, notes and bonds by investors abroad fell to $15.6 billion in December, the lowest in almost five years, according to the Treasury Department. „Central banks are diversifying further in terms of instruments, currencies and markets,” wrote Nick Carver, an assistant editor at the London-based Central Banking Publications in the report called RBS Reserve Management Trends 2007. The US currency traded at $1.3182 per euro at 6:30 a.m. in London from $1.3166 on February 23. The pound stood at $1.9625 from $1.9633. The dollar bought 120.97 yen from 121.08. Nineteen of 47 central banks surveyed had cut their share of dollars, while 10 said they had increased holdings. Twenty-one respondents said they had increased their reserves of euros, compared with seven who said they had reduced their holdings of the single currency. The 47 respondents in the survey hold a total of $1.5 trillion in reserve assets.

Nine central banks also increased their share of the pound, citing the yield on sterling-denominated assets as the most popular reason. Central banks bought $36.2 billion of reserves in pounds in the four quarters ended September 2006, according to the IMF. The Bank of England last month raised interest rates to a five-year high of 5.25%, with the consequent higher yield in UK assets attracting investors. That compares with a benchmark rate of 3.5% in Europe and 0.5% in Japan. 36% of the 47 central banks that responded said they have made „major changes” to their investment strategy in the last two years, the poll said. 89% said central banks haven't approached the limits of „practical” diversification, according to the poll. Central banks are still investing in riskier assets as they chase greater returns on yields. Sixty-nine% said they were looking for more yield, having been forced to widen their asset range by a low-yielding environment. More than half of the respondents said there is scope for central banks to diversify beyond traditional assets into equities, and around a third said banks should invest in commodities. (Bloomberg)