Correction to Pound Reserve Story

By Mike Bird Features Dow Jones Newswires

Sterling's status as a global reserve currency is little-changed a year after Brexit, a vote that prompted predictions of the pound losing favor among central banks.

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The share of global foreign reserves held in sterling has edged up for the first time since the end of 2015, according to data from the International Monetary Fund published Friday.

Of the world's $9.264 trillion in allocated foreign exchange reserves, 4.4% of the total, or $408.1 billion, was held in sterling-denominated assets during the second quarter of 2017, from 4.3% in the first quarter of the year.

Central banks and governments buy assets denominated in reserve currencies -- mainly the dollar, yen, euro and pound -- to give them a pool of liquid securities that, in an emergency, can be sold to prop up the value of their own currency

Following last June's vote to leave the European Union, the pound plummeted and some analysts predicted the currency's remaining place in the reserves of central banks would fade, mainly as the country's giant financial services sector declined and increased volatility made it less attractive to hold.

But asset managers that work closely with central banks say they don't believe that these massive buyers have already begun to pare back sterling holdings, or will soon do so. Most central banks with large reserves don't independently publish their currency breakdown.

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"To the extent we've talked to reserve managers about this, they haven't noted any fundamental change in the way they view sterling relative to anything else," said Gavin Ralston, head of official institutions at Schroders.

The pound has lost around 11% of its value against the dollar and 13% against the euro following last June's referendum.

The U.K's role as a reserve currency has diminished for decades, from its historical position as the dominant currency in global finance in the early 20th century. As recently as 1964, the U.K's share of international reserves was slightly over 25%, according to the IMF.

But while central banks don't buy as much sterling as they once did, they buy enough to provide a reliable source of demand for British government bonds, which can reduce borrowing costs in the country. It can also act as a buffer against volatile currency movements, buying when the pound weakens and selling when it strengthens. The very designation of being a reserve currency is also a stamp of stability, making assets denominated in them more attractive across the investment world.

Holders of foreign exchange reserves tend to have different priorities than other investors. The mantra of reserve managers is that investments should offer liquidity, safety and returns, prioritized in that order, according to fund managers that help manage them.

In the second half of 2016, the pound was still by some distance the fourth most liquid currency in the world. In the second half of the year 19.9% of the $68.598 trillion market in foreign exchange contracts had a sterling leg. Since each contract has two currency legs, all the contracts in this accounting sum to 200%.

"I have some sympathy for the argument that the U.K. could be less attractive for foreign direct investment because of the referendum, but to automatically extend that to reserves isn't right," said Gary Smith, who works with sovereign-wealth funds and official institutions at Barings Asset Management.

Another factor that could currently support the pound's continued position as a reserve currency is its relatively high yield against other currencies.

The yen and euro offer deep markets but meager returns. Japan and the eurozone have ongoing bond-buying programs and negative interest rates, which have pushed down returns for investors, especially on government bonds and the highest-rated corporate credit.

"For reserve managers one of the problems is that reserves are burning a hole in their pockets, low yields or even negative where the income returned to them is extremely low," said Arnab Das , head of emerging markets macro research at Invesco Perpetual.

The U.K's higher yields could still prove to be attractive. Ten-year British government bonds, for instance, currently yield around 1.33%, against 0.07% for the same maturity in Japan and 0.45% for German bunds.

"Even if people conclude that, because of Brexit, the U.K. becomes less of a reserve currency, but still has a deep and liquid market in which it's possible to generate higher returns on investments, they might use it as a diversifier," Mr. Das added.

Central banks and sovereign-wealth funds may have other another reason to remain in U.K. assets -- the need to diversify out of the dollar. Sovereign-wealth funds aren't included in the IMF's data.

"Heavy buying particularly in dollar credit has left them very long against their limits in dollars," said Luke Hickmore, senior investment manager at Aberdeen Standard Investments, speaking of sovereign-wealth funds. Mr. Hickmore met with some of the funds' managers in Asia this spring.

"Sterling still works if you're trying to get diversification."

To be sure, central banks aren't known for rapidly changing their investment decisions, and a decline in sterling's share of currency reserves could yet come.

The latest raft of IMF data on reserves is also complicated by the fact that the People's Bank of China's holdings have been incrementally added since 2015, meaning that the most recent figures aren't like-for-like.

Some analysts maintain that sterling's days as a reserve currency are numbered.

"Historically over the long term you tend to see the correlation between the reserve status of a currency and its importance in global trade," said Frank Gill, director of European sovereign ratings at S&P Global Ratings. Following Brexit, analysts at the credit ratings firm were among those who predicted that sterling could lose its reserve status.

"Brexit is over time going to weigh on the City of London. It's the biggest center of currency trading in the world and at some point this will absolutely put at risk the reserve status," Mr. Gill added.

Write to Mike Bird at Mike.Bird@wsj.com

Corrections & Amplifications

This article was corrected at 1631 GMT because an earlier version gave an incorrect spelling of Luke Hickmore's name.

Luke Hickmore is a senior investment manager at Aberdeen Standard Investments. The story, "Despite Brexit, Pound Remains a Reserve Currency--But for How Long," published at 5:30 a.m. ET gave an incorrect spelling of his name.

(END) Dow Jones Newswires

October 03, 2017 11:45 ET (15:45 GMT)