Euro's falling share in global reserves to accentuate weakness

LONDON: The euro's share in global foreign exchange reserves has fallen to its lowest in more than a decade, a trend that is likely to pick up in coming months and hold down the currency's value.

Data from the International Monetary Fund this week showed the euro's reserve share fell to 22.2 percent in the fourth quarter of 2014, from 22.6 percent in the third. The dollar's share rose to 62.9 percent from 62.4 percent.

While most of the drop reflects a 4 percent fall in the value of the euro during the fourth quarter, the drop in its reserve share was much less than the fall in its value, implying reserve managers were only just beginning a gradual shift away.

Analysts expect that trimming of euro reserves to accelerate in the coming quarters. Deutsche sees the euro share at just over 20 percent in the first quarter of 2015, while JPMorgan estimates a drop to 19.8 percent.

Deutsche strategist George Saravelos said Middle Eastern central banks, with $1 trillion in currency reserves and $2.5 trillion in sovereign wealth holdings, and the Chinese central bank, with $3.84 trillion, were particularly likely to lighten their euro holdings.

These countries have been the biggest buyers of the euro in the past 15 years. Now lower oil revenues mean Middle Eastern states will need to fund fiscal deficits from their reserves. China, too, is drawing down on its reserves, the world's biggest.

"It is precisely these holders that have the largest ongoing potential to sell euros," Saravelos said.

At its peak in 2009, the euro's share of global reserves hit 28 percent, having climbed from a low of 17.8 percent in 1999. During that period the euro gained over 60 percent against the dollar.

Even at the height of the euro zone debt crisis in 2011/12, reserve managers sought the euro and diversified out of the dollar as the Federal Reserve pumped out money to reflate the economy.

PASSIVE SHIFT AWAY

Now the European Central Bank has unleashed a 1 trillion euro asset purchase programme, while the Fed is likely to tighten policy in coming months, boosting the dollar.

The euro lost 4 percent against the dollar in the last quarter of 2014. That is partly to blame for the drop in the share of euros in global reserves in the fourth quarter of 2014, analysts said.

"The fact that their share among allocated reserves fell does not only reflect a valuation effect due to euro depreciation," said Commerzbank strategist Ulrich Leuchtmann. "It also shows that central bank reserve managers now are satisfied with a smaller euro share."

Central banks are key players in the $5-trillion a day currency market and tend to conduct their business discreetly so as to minimise market volatility. They rarely change the mix of reserves they hold, which are mainly used to match their liabilities.

Since the global financial crisis, with the most liquid currencies like the dollar offering very little in returns given official rates stuck near zero, a few reserve managers have diversified into higher-yielding currencies.

However, with the dollar rising and U.S. yields moving higher, many are shifting back, mostly at the expense of the euro and, to a degree, the Australian and Canadian dollars.

That quiet shift in reserve allocation coincides with a debate about whether China's yuan should be included in the IMF's basket of global currencies, just like the dollar, the euro, the yen, sterling and the Swiss franc .

But for Willem Buiter, chief economist at Citi, "the dollar is the only real reserve currency out there. The euro has come up short and the yuan is still in the waiting room."