Euro’s Drop is a Turning Point for Central Banks Reserves …

Central banks and reserve managers are breaking from past practice by showing little appetite to add euros as the currency tumbles.

The total amount of reserves held in euros fell 8.1 percent in the third quarter, more than the currency’s 7.8 percent decline in the period against the dollar, according to the most recent figures from the International Monetary Fund. The last two times the euro depreciated 7 percent or more in a quarter, 2011 and 2010, holdings declined much less.

The data suggest reserve managers are passing up the chance to buy euros while they’re cheap, removing a key pillar of support. In August, European Central Bank President Mario Draghi cited the drop in central banks’ euro holdings as a factor that would help weaken the exchange rate and ultimately boost the region’s faltering economy.

“Central banks have found new reasons not to feel comfortable with the euro,” Stephen Jen, managing partner and co-founder of SLJ Macro Partners LLP in London, said by phone on Jan. 6. “Nobody wants to have a negative yield. You’re not keeping a currency to lose money.”

Negative Rates

The ECB has experimented with negative interest rates on deposits in an attempt to draw money out of safe government debt and into the broader economy. Yields on two-year notes in Germany, the Netherlands and France are all below zero on speculation the ECB is losing the battle against deflation.

Policy makers are signaling they are ready to step up the fight by expanding the money supply through further stimulus, such as purchasing government debt, that typically weigh on a currency’s value. Adding to the pressure is concern that Draghi won’t be able to hold the currency bloc together amid signs Greece may quit the euro area after its Jan. 25 election.

The 19-nation euro fell in each of the past six months, dropping to $1.1843 today, its lowest level since February 2006. The currency was at $1.1868 as of 9 a.m. in London, down 15 percent from last year’s high of $1.3993 on May 8.

A spokesman for the Frankfurt-based ECB, who asked not to be identified, said yesterday by e-mail that the international role of the euro is primarily determined by market forces and the central bank neither hinders nor promotes it.

Slowing Economy

The amount of euros held in allocated reserves — or those where the currency is specified — fell to $1.4 trillion in the third quarter, or 22.6 percent of the total, from $1.5 trillion, or 24.1 percent, at the end of June, according to figures published by the IMF on Dec. 31. The proportion is the lowest since 2002 and down from as much as 28 percent in 2009.

A weaker euro is key to Draghi’s attempts to boost an economy that is slowing and push inflation up toward 2 percent, from a forecast minus 0.1 percent in December, according to a Bloomberg News survey before today’s report.

The decline in reserves allocated to the euro was more than four times the combined drop in holdings of yen, Swiss francs, pounds and Canadian and Australian dollars. The U.S. dollar was the only currency in which reserves rose, with a $23.9 billion jump to $3.9 trillion, or 62.3 percent of the total.

With the euro’s decline versus the dollar in the third quarter taken into account, the slide in holdings totaled only about $2.5 billion, according to a report by BNP Paribas SA on Jan. 6.

‘Euro’s Troubles’

“It was both active euro selling and valuation effects which drove the fall in the euro’s allocation,” Anezka Christovova, an analyst at Credit Suisse Group AG in London, wrote in a report Jan. 5. Central banks reverting to dollar reserves “should add to the euro’s troubles,” she said.

In the third quarter of 2011, the common currency slid 7.7 percent, while its reserves fell 2.8 percent. A deeper plunge of 9.4 percent in the euro in the second quarter of 2010 only prompted a 1.3 percent loss in holdings, the IMF data showed.

The euro will fall about 1.5 percent to $1.17 by year-end, according to the median forecast of more than 50 strategists compiled by Bloomberg. Separate surveys suggest the euro will weaken against 23 of 31 major peers.

Credit Suisse is more pessimistic than the consensus, predicting a slide to $1.15 this year, according to a Dec. 17 forecast. Deutsche Bank AG, the world’s second-largest currency trader, also targets $1.15 for year-end.

The Washington-based IMF’s figures “suggest that there’s been genuine off-loading of euro reserves,” Alan Ruskin, global head of Group of 10 foreign exchange at Deutsche Bank in New York, said by phone on Jan. 6. “The share has dropped very steadily. There’s definitely a trend in place.” .Source: Bloomberg