Quantitative easing may be helping Europe achieve its economic targets, but it’s also undermining the long-term viability of the euro by tarnishing its allure as a global reserve currency.
Central banks cut their euro holdings by the most on record last year in anticipation of losses tied to unprecedented stimulus. The euro now accounts for just 22 percent of worldwide reserves, down from 28 percent before the region’s debt crisis five years ago, while dollar and yen holdings have both climbed, the latest data from the International Monetary Fund show.
“As a reserve currency, the euro is falling apart,” said Daniel Fermon, a strategist at Societe Generale SA in Paris. “As long as you have full quantitative easing, there’s no need to invest. The problem for the moment is we don’t see a floor for the currency. Money’s flowing out.”
European Central Bank President Mario Draghi has in the past welcomed the drop-off in reserve managers’ holdings because a weaker exchange rate makes the continent more competitive. Yet firms including Mizuho Bank Ltd. warn the currency’s waning popularity reflects a more lasting loss of confidence in an economy that shrank in two of the past three years.
“Global reserve managers may be thinking the euro is going to sink economically if it continues this way,” said Daisuke Karakama, the Tokyo-based chief market economist at Mizuho and a former European Commission official. With yen allocations rising, “they may be expecting Japan’s positive economic growth to continue as a result of” that nation’s record stimulus, Karakama said.
The decline in euro reserves suggests other central banks consider the ECB’s 1.1 trillion euros ($1.2 trillion) of QE bond purchases, which started a month ago, to be the biggest threat to the currency’s global status since its 1999 debut.
Greece’s debt woes aren’t helping, either. The ECB ramped up the emergency funding available to Greek banks Thursday to alleviate the country’s worsening liquidity issues amid drawn-out negotiations over its bailout.
All this is prompting banks from Citigroup Inc., the world’s biggest foreign-exchange trader, to Goldman Sachs Group Inc. to predict the euro will fall below parity with the dollar this year, from a 12-year low of $1.0458 last month and $1.0617 Friday.
National Australia Bank Ltd. estimates reserve managers sold at least $100 billion-worth of euros in the fourth quarter of 2014.
“Most of the fall in the euro share represented outright selling of euros” rather than simply reflecting declines in the exchange rate, said Ray Attrill, the bank’s global co-head of currency strategy in Sydney.
Of the $6.1 trillion of reserves for which central banks specify a currency, the proportion of euros fell in every quarter of 2014, IMF data show. Last year was also the first time euro holdings fell in cash terms.
Yen holdings increased in three of the four quarters and make up 4 percent of the total, up from as low as 2.8 percent in early 2009. Dollars account for the biggest proportion at 63 percent after reserve managers increased their holdings in the final six months of last year. That’s down from as much as 73 percent in 2001.
The changes came as the yen and euro each sank 12 percent versus the greenback last year. The euro has tumbled about the same amount since then, which should further shrink its presence in central banks’ war chests.
While Draghi has acknowledged that a weaker euro helps the region’s economy, he’s repeatedly insisted his policies don’t target the exchange rate. His priority is to avert a deflationary spiral, after consumer prices fell in each of the four months through March compared with a year earlier.
The euro’s also falling against its broader peers, dropping more than 7 percent this year among a basket of its Group of 10 nations tracked by Bloomberg Correlation-Weighted Indexes, the biggest decline in the group. The dollar climbed almost 7 percent on the prospect of higher U.S. interest rates, beating a gain of about 6 percent in the yen.
“QE does not create the conditions for a euro recovery,” Ken Dickson, investment director for currencies at Standard Life Investments Ltd. in Edinburgh, wrote in a note Thursday. His firm oversees about $360 billion. “We retain a preference for the U.S. dollar versus other major currencies.”