Central banks snap up sterling in buying spree

NEW YORK - Central banks from Oman to the Ukraine are increasing their holdings of sterling, contributing to the currency's biggest first-half gain against the US dollar in 16 years.

National banks boosted holdings of pounds to US$115 billion ($188 billion), or 4 per cent of total reserves at the end of March, the most since the International Monetary Fund began publishing data in 1999. The increase is helping Britain's economy by holding down government bond yields.

"The pound is attractive because it has a good return on interest rates," Hamoud Al Zadjali, president of the Central Bank of Oman, said. Oman holds 5 per cent of its US$4.7 billion of reserves in sterling.

The pound's share of reserves has risen from 3.7 per cent at the start of last year and 2.7 per cent in March 2004. Britain's currency surpassed the yen in December as the third-most popular after the US dollar, which makes up 66.3 per cent and the euro, at 24.8 per cent. The IMF includes data from 114 countries that hold US$4.4 trillion worth of foreign currencies.

The 7.4 per cent rally from January through June was the best first half since the pound gained 19.7 per cent in 1990. That surge was sparked by the decision to tie it to European Union currencies, including Germany's deutschmark and the French franc.

Two years later, billionaire George Soros and other speculators bet Prime Minister John Major would pull out of the European Monetary System. They pressured the Bank of England to abandon the link and triggered a 20 per cent drop over the next three months. Soros made US$1 billion for his Quantum fund on the wager.

Investors, traders and strategists surveyed by Bloomberg are predicting more pound gains, while 61 per cent of those polled advised selling the US dollar against the euro, up from 50 per cent from the week before. Fifty-seven per cent urged selling it against the yen, up from 52 per cent. Demand for pounds is being propelled from central banks, mainly in developing countries. Emerging-market countries including China and oil exporters such as Russia, now hold US$2.9 trillion in reserves, about two-thirds of the total. They accounted for almost all of the growth since 2004, says an analysis by Deutsche Bank. The pound is attractive in part because of Prime Minister Tony Blair's success in slowing inflation and spurring growth.

Consumer price gains have averaged 1.4 per cent since May 1997 when Blair took office. The inflation rate averaged 4 per cent in the five previous years. Economic growth of 2.3 per cent in the first quarter was faster than the average for the 12 nations sharing the euro.

Central-bank purchases of the pound reduced 10-year UK bond yields by as much as 150 basis points from June 2004 through the end of last year, said Gertjan Vlieghe, an economist at Deutsche Bank.

"We have seen a big increase in central-bank buying of sterling, and those purchases have helped keep yields low."

UK 10-year bond yields fell to 4.64 per cent last week from 4.70 per cent the week before. In the US, 10-year Treasury notes yield 5.13 per cent.

Higher UK interest rates have made the pound attractive to some industrialised countries. The Bank of England's benchmark rate is 4.5 per cent compared with the European Central Bank's 2.75 per cent.

"I doubt we've seen the peak in central bank buying yet," Michael Saunders, London-based chief economist for Western Europe at Citigroup, said.

- BLOOMBERG