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29/00

2 March 2000

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

OCTOBER­-DECEMBER 1999

This report contains a short commentary on foreign exchange market developments during the three months October ­ December 1999 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. Sterling appreciated slightly over the quarter in effective terms. The dollar appreciated against the euro and sterling, but fell against the yen. The yen continued to appreciate. The euro continued to depreciate.

Sterling developments

2. Sterling appreciated over the period in effective terms by 2.0%. Within this overall movement, it appreciated by 4.0% against the euro (which has a 65% percent weight in sterling's effective exchange rate) and depreciated against the US dollar and Japanese yen, by 2.1 percent and 5.9 percent respectively.

Table A: Exchange rates & effective exchange rate indices

Source: Bank of England * change in £/euro

International developments

3. The US dollar's effective exchange rate index appreciated by 0.8 percent over the period; a 3.9 percent depreciation against the Japanese yen and a 1.2 percent depreciation against the Canadian dollar (which account for around 30% and 25% of the dollar's effective exchange rate index respectively), were outweighed by a 6.2 percent appreciation against the euro and a 2.1 percent appreciation against sterling.

4. Following a rise of 12.1 percent in the third quarter of 1999, the Japanese yen's effective exchange rate index appreciated by a further 6.3 percent in the fourth quarter. The yen rose sharply against the euro, appreciating by 10.5 percent.

5. The euro continued to depreciate over the period, falling by 5.8 percent against the dollar and by 3.8 percent and 9.5 percent against sterling and the yen respectively. The euro's effective exchange rate index fell by 4.4 percent.

6. Gold briefly hit two year highs at the start of October, reaching almost $340 an ounce at its highest, as the market considered the implications of the announcement made on 26 September by 15 European central banks (including the Bank of England on behalf of HM Treasury) to limit their gold sales and not to expand their gold lending or derivatives activity. By the end of October, gold had fallen back below $300 and then traded in a range between $275 and $295 to end the quarter at $290.25 per ounce.

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

7. 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. As a result of 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

8. As shown in Table 1, during the quarter to end-December, the total of foreign currency and gold reserves in the EEA rose by $ 403mn from the end-September figure of $ 32,650mn to $ 33,053mn. Capital and Other Items totalling $ 408mn accounted for the increase^(1).

The underlying change in the reserves, that is the change net of Capital and Other Items, was a decrease of $ 5mn. If translation to US dollars had been carried out at prevailing market rates rather than at the parity rates set at end-March, the total of gold and foreign currency reserves in the EEA would have been $ 34.7bn at end-September and $ 34.2bn at end-December. The difference between the total at prevailing market rates and at parity rates is primarily due to the 25% discount applied to the value of gold at end-March in calculating the reserves at parity rate.

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-December.

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. In October, the UK reopened the 2.75% 2002 Euro Note by selling a further 500mn of the issue. The total of Euro and ECU notes and bonds outstanding with the public therefore rose from 8.0bn to 8.5bn during the quarter. By October, the Euro Treasury Bill programme had come to a close and the Bank of England had fully taken over as issuer of Euro Bills. Repayments of non-marketable debt are shown in Note 6 to the EEA tables.

12. On 7 May, HM Treasury announced a restructuring of the UK's reserve holdings involving a programme of gold auctions in 1999/2000. The third of these auctions took place on 29 November. Twenty-five tonnes of gold was sold at a price of $293.50. Further details about the programme are available from the Treasury and Bank of England Press Offices and their respective web sites.

Bank of England Holdings

13. The Bank of England's holdings of foreign currency and gold stood at $ 8,092mn at the end of the quarter. These arose from the following operations:

• 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;
• foreign exchange swaps conducted as part of the Bank's domestic sterling money market operations. These swaps are undertaken as a supplement to the Bank's usual money market techniques to provide sterling liquidity to the market, and are purely technical in nature;
• foreign exchange swaps and foreign currency-denominated securities, interest rate swaps and asset swaps undertaken to fund and hedge the euro balances that the Bank holds as a consequence of the UK's connection to the TARGET payments system;
• euro balances with other central banks operating the TARGET system. These are very largely off-set by similar balances that the other central banks hold at the Bank and as a result are shown net in the tables below, where they account for $ 282mn at end-December. The gross amount at end-December was $ 7,249mn.

14. 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-December was an increase of $ 556mn. However, there was no underlying change during the quarter. The underlying change excludes the change in valuation over the quarter, 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 and asset swaps conducted in the course of the Bank's money market operations and in connection with TARGET, changes in euro balances with other central banks operating the TARGET system, and other capital items.

15. By the beginning of the quarter, the Bank of England had taken over from HM Treasury as the issuer of Euro Bills. 300mn of six-month, 500mn of three-month, and 200mn of one-month Bank of England Euro Bills were issued in each of the three months during the quarter. The total nominal amount of Bank of England Euro Bills was therefore maintained at 3.5bn throughout the quarter. The proceeds of Bank of England Euro Bills are used by the Bank to finance the provision of intra-day liquidity, on a secured basis, to participants in CHAPS Euro, as part of the arrangements for TARGET.

16. As set out in the Chancellor's letter of 6 May 1997 to the Governor, the Bank may 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-December.

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 DECEMBER 1999

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.

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-December these comprised three US dollar bonds (two fixed-rate and one floating-rate) totalling $ 7bn; and two Euro Notes, one ECU Note and an ECU bond totalling h 8.5bn ($ 8.5bn equivalent). 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 current 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 1999 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.

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 1999 is US$ 209.59 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 the overall change:

• There were repayments of $ 21mn of public sector borrowing for which HMG has provided an exchange rate guarantee under the Exchange Cover Scheme (ECS);
• Receipts from the issue of HMG's 2002 Euro Note totalled $ 519mn;
• There were repayments of HMG debt assigned from the public sector of $ 1mn;
• There were repayments of $ 157mn of long term debt arising from loans received from the US and Canadian government during the Second World War.

7. The underlying change also excludes the difference between the valuation of the gold auctioned on 29 November at the parity rate of $ 209.59 per troy ounce and the auction allotment prices ($ 293.50 per troy ounce) amounting to $ 68mn.

8. 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.

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.

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.

1. See Note 6 to the EEA Tables.

2. Includes residual balances denominated in the predecessor currencies of the euro.