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203/98

2 December 1998

QUARTERLY REPORT ON UK OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD: JULY - SEPTEMBER 1998

The Treasury and the Bank of England published today the Quarterly Report on UK official holdings of foreign currency and gold for the period July to September 1998. The report gives details of the forward foreign exchange position, the currency composition of foreign currency assets, the size and currency composition of foreign currency liabilities for the Exchange Equalisation Account (EEA) and the Bank of England's holdings of foreign currency and gold.

The report shows that the level of the Government's reserves, including the forward book was $36.6 billion at end-September, an underlying increase of $9 million on end-June. Net forward holdings of foreign currency were $1.28 billion at end- September.

The level of the Bank of England's holdings of foreign currency and gold was $2.75 billion at end-September.

No intervention operations were undertaken during the quarter to end-September with either the Government's reserves or the Bank of England's holdings.

NOTES TO EDITORS

1. Media copies of the quarterly report are available from the Treasury Press Office on 0207 270 5185 or from the Bank of England Press Office on 0207 601 4411.

2. Non-media copies of the report are available from the Treasury Public Enquiry Unit on 0207 270 4558 or from the Bank of England on 0207 601 4878.

4. The quarterly report covering October - December 1998 will be published on 2 March 1999.

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QUARTERLY REPORT ON THE UNITED KINGDOM OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD JULY SEPTEMBER 1998

This report contains a commentary on foreign exchange market developments during the three months July September 1998 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

Summary

1. The focus for foreign exchange developments in the third quarter was the volatility in emerging markets. The trigger was the announcement on 17 August of the floating of the Russian rouble and of a partial moratorium on Russian debt repayments. Exchange rates were affected by capital flows towards the most liquid markets and by shifting interest rate expectations. Equity markets fell worldwide. Sterling and the US dollar both depreciated during the third quarter as expectations of the levels of interest rates in the United Kingdom and United States were revised downwards.

Sterling developments

2. Table A shows that sterling fell by 3 1/2% on a trade- weighted basis against the other major currencies during the period, with most of the depreciation occurring during September. Though sterling initially appreciated against the Deutsche Mark following the Russian announcement (up 5 pfennigs during August), it fell by more than 10 pfennigs during September as UK interest rate expectations were revised down. Sterling rose slightly against the dollar as US interest rate expectations were also revised down.

Table A: Exchange rates and effective exchange rate indices

Source: Bank of England

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International developments

3. The Russian developments in August, and imposition of exchange controls in Malaysia announced on 1 September, led to a general review of default risk in emerging markets. Some Latin American exchange rates, in particular, came under pressure to devalue. This had a knock-on effect to the US dollar because Latin America has closer trade and capital links with the US economy than with other industrialised economies. US interest rate expectations were revised down and the Federal Funds target rate was cut by 25 basis points to 5¬% at the end of September. The US dollar fell by more against the Deutsche Mark than against the yen, partly because the Japanese authorities also cut interest rates in the third quarter.

4. Within Europe, exchange rates of countries that will participate in EMU were largely unchanged against the Deutsche Mark during the third quarter. But other European currencies were more volatile as capital flowed towards the most liquid markets. For example, the Norwegian and Swedish Krone fell by 4% and 6% respectively against the Deutsche Mark. The depreciation of the Norwegian Krone also partly reflected the weakness in oil prices. The weakness in primary product markets also affected other commodity exporting countries' exchange rates; the Australian and Canadian dollars fell to historical lows against the US dollar during the third quarter.

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II: THE LEVEL AND COMPOSITION OF UK OFFICIAL HOLDINGS OF FOREIGN CURRENCY AND GOLD

5. 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. Due to differences in accounting methodology that are explained in the footnotes to the tables, no overall total for the EEA and Bank holdings is shown.

EEA Holdings

6. As shown in Table 1, during the quarter to end-September the total of foreign currency and gold reserves in the EEA increased by $ 534 mn. The increase was almost entirely accounted for by the increase in Capital and Other Items totalling $ 525 mn. The most significant factor was the auction of E 500 mn ($ 589 mn) of Euro Notes. The underlying change in the reserves, that is the change net of Capital and Other items, was an increase of $ 9 mn. Interest receipts exceeded interest payments during the quarter: as explained in the notes to the tables, interest is accounted for on a cash basis and the net total is therefore subject to considerable variation. This was offset by small net sales of foreign currency.

7. During the quarter the UK contributed to international financial support operations overseen by the International Monetary Fund. The UK's reserve tranche position at the IMF increased by $ 387 mn to $ 3,461 mn. The UK contribution to the activation of the IMF's General Arrangements to Borrow was a further $ 193 mn.

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8. Under EEA accounting methodology the non-US dollar assets of the EEA are translated to US dollars at exchange rates (termed 'parity rates') that are set at the end of March each year and which apply for the subsequent twelve months. The method of calculation of parity rates, and the level of the major rates, is set out in Note 3 to the EEA Tables. If translation to US dollars had been carried out at prevailing market rates, the total of gold and foreign currency reserves in the EEA would have been $ 39.8 bn at end-September and $ 38.0 bn at end-June compared to $ 36.6 bn and $ 36.0 bn respectively at parity rates.

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. The second reopening of the Government's 4.25% 2001 Euro Note was held in July; E 500 mn was sold at this tender. The total of Euro and ECU Notes and bonds outstanding with the public therefore rose from E 7.5 bn to E 8 bn during the quarter. On 7 July the Bank issued, on behalf of the Government, a Euro Treasury Bill Information Memorandum which changed the denomination of the UK Government ECU Treasury Bill programme into euro for bills maturing after the start of 1999. Tenders totalling ECU 0.7 bn of ECU Treasury Bills and E 0.3 bn of Euro Treasury Bills were held each month, comprising ECU 200 mn of one-month, ECU 500 mn of three-month and E 300 mn of six- month bills. The total of Bills outstanding with the public was therefore maintained at the equivalent of ECU 3.5 bn. Repayments of non-marketable debt are shown in footnote 6 to the EEA tables.

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Bank of England Holdings

12. The Bank of England's holdings of foreign currency and gold during the quarter arose partly from 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, and partly from foreign exchange swaps conducted as part of the Bank's domestic sterling money market operations. These foreign exchange swaps were undertaken as a supplement to the Bank's usual money market techniques to provide sterling liquidity to the market. The operations are purely technical in nature and have no monetary policy significance.

13. 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 $ 1,090 mn. The underlying change excludes the change in valuation over the month, 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 swaps conducted in the course of the Bank's money market operations, and other capital items. There was no underlying change during the quarter.

14. As set out in the Chancellor's letter of 6 May 1997 to the Governor, the Bank may also 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.

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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 1998

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.

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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 $ 7 bn, a Euro Note totalling h 1.5 bn ($ 1.76 bn equivalent), two ECU Notes totalling ECU 4.0 bn ($ 4.7 bn equivalent), an ECU bond totalling ECU 2.5 bn ($ 2.9 bn equivalent) and ECU 3.5 bn ($ 4.1 bn equivalent) of ECU and Euro Bills. 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 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 1998 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.

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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 1998 is US$ 220.66 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 he overall change:

• Receipts from HMG Euro Treasury Notes issued totalled $ 541 million.
• Revaluation arising from EMI swap of $ 38 million. Due to the mechanics of the swap this appears as a negative figure in the spot reserves, balanced by a positive entry in the forward book.
• There were repayments of $ 16 million of public sector borrowing for which HMG has provided an exchange rate guarantee under the Exchange Cover Scheme (ECS).
• Receipts from HMG ECU Treasury Bills issued exceeded repayments on those maturing by $ 1 million.

7. 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.

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Notes to the Bank of England Tables

1. 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.

2. The Bank's foreign currency and gold assets and liabilities are published annually in the Bank's Report and Accounts.

3. The Bank's contribution to the European Monetary Institute (EMI) of ECU 95mn (US$ 112 mn at the end-September exchange rate) is largely funded by a deposit from the EEA of ECU 93 mn. This deposit therefore appears both as a foreign currency liability of the Bank and as an asset of the EEA.

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.

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Press Notices 1998 July to December Index