Europe's dream of toppling dollar fades

International Monetary Fund data show that emerging nations have cut the weighting of EMU bonds in their reserves to 24.7pc from a peak of 30pc at the onset of Europe’s crisis three years ago, with a record drop in the third quarter of 2012.

“They have lost their appetite for peripheral EMU bonds, and some have simply cut Italy and other countries from their benchmarks,” said Jens Nordvik, currency chief at Nomura.

The IMF data also show a record $19bn (£12bn) surge in holdings of sterling by advanced central banks to $98bn, the biggest three-month jump ever recorded. Analysts say this is almost certainly caused by the Swiss National Bank as it takes extreme measures to hold down the franc. The SNB has already bought an estimated $80bn-worth of euro bonds and is increasingly switching to other assets.

“There aren’t many places to go in this 'ugly contest’ if you don’t like the euro, dollar or yen,” said HSBC’s David Bloom.

The effect has been to thwart the Bank of England’s efforts to weaken the pound. The Swiss and UK central banks are effectively in a “low intensity” battle against each other. “This is what happens in currency wars. Desperate times lead to desperate acts,” said Mr Bloom.

A weaker euro may be a blessing in disguise for European industries struggling with an overvalued exchange rate. Former French leader Charles de Gaulle once called dollar hegemony America’s “exorbitant privilege”, but the eurozone has learnt that reserve status can also be an exorbitant burden.

Central banks increased their holdings of eurozone bonds by an estimated $1.5 trillion in the early EMU years as China, Russia and the Middle-Eastern petro powers invested fresh reserves in euros to diversify away from the dollar. This pushed the euro to an all-time high of $1.60 by 2008, a level that inflicted serious damage on the manufacturing bases of France, Italy and Spain. It also distorted the EMU credit structure, fuelling debt booms across Club Med.

“There was too much euro buying. It is probably a good thing if the central banks pull back, so long as it does not go too far and lead to a buyers’ strike,” said Mr Nordvig.

^{Source: Nomura/IMF}

Asia’s trade tigers dominate global reserves, holding almost two-thirds of the $10.8 trillion total along with commodity exporters. China holds $3.3 trillion.

Advanced central banks have increased their euro holdings over the past year, but that is entirely due to Swiss intervention, a “one-off” anomaly, and may have stopped already.

The broader retreat from EMU bonds has not stopped the euro rising 8pc since July to $1.31 against the dollar. Hans Redeker, from Morgan Stanley, said this is largely due to deleveraging by European banks, which are cutting global exposure to meet tougher capital ratios. “It is a repatriation effect, but it won’t last. We think the euro will fall much closer to parity within two years,” he said.

The Telegraph