UK: Sterling's lost reserve status – Deutsche Bank

Robin Winkler, Strategist at Deutsche Bank, notes that the foreign investors have returned to the UK gilt market over the past quarter as valuations are attractive in dollar terms.

Key Quotes

“Yet although this may have involved some recycling of petrodollars, we are skeptical that sterling will benefit from a broader reallocation of EM currency reserves managed by central banks. To the extent that reserves serve as backstops against currency stress, rather than as sovereign wealth, the pound’s diminishing role in international capital flows post-Brexit should permanently reduce its reserve status. Central banks stock currencies to which their own currencies are most susceptible via trade and capital flows.”

“Academic work shows that global reserve allocations closely match the relative sizes of the major currency blocs. These are calculated as the betas of each global currency to the reserve currencies—USD, EUR, and GBP—multiplied by the relative sizes of the respective economies. This currently allocates 47% to the dollar. Combined with America’s 16% share in the global economy, this exactly matches the dollar’s 63% share in COFER reserves. For the euro, the model is equally precise in predicting the 20% COFER share. For sterling, the 6% share is close to the 5% COFER share.”

“Running this model dynamically shows that the sterling bloc has halved since early 2015. Is that already reflected in actual allocations? At first sight, the stable COFER share suggests no. But the fact that China only started to report allocations over that period may have masked a drastic slimming in their former pound overweight. In a model of China’s currency allocation we describe elsewhere, we estimate that the pound’s share has likely fallen from close to 10% into low single digits since early 2015, consistent with the PBoC transitioning from wealth to currency management. The pound may offer value but is increasingly irrelevant.”