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Tuesday, May 17, 2005

Central Banks The Dollar and the Euro

The Financial Times is drawing attention to continuing moves by Central Banks to diversify their reserves away from dollar based instruments. It also seems that there is an increased temptation to do this at a time when the dollar is on a 'light rebound'. In this case they can switch reserves without risking provoking a stampede. The euro is now down around $1.26. From the point of view of economies like Italy and Germany this gradual decline could continue, but the realities of the global economy, and among these this long term trend to diversification (the other could area would, of course, be the continuing US current account defecit), make it more probable that - in the mid term - we will once more see upward pressure on the euro.

"The world's central banks were net sellers of US assets in March for the first time since September 2002, according to figures that may hint that the recent rebound in the dollar will be temporary. Central banks sold a net $14.4bn in US assets during the month, the largest sale since August 1998, the US Treasury revealed....

Private-sector inflows into the US remained robust in March at $74.5bn, only slightly down from $79.4bn in February.

“It does seem that when private sector investors are willing to buy dollars, the central banks are happy for any excuse to offload part of the mountain of dollars they have accumulated,” said David Bloom, currency strategist at HSBC.

Demand for US Treasuries was boosted by $28bn of net purchases from the Caribbean region, the highest level in at least four years. Analysts associate banking centres in the Caribbean with hedge funds.

Some analysts suggest that hedge fund buying of US government bonds in recent months may be associated with unwinding failed bets in which the funds were short on Treasuries while owning riskier, higher-yielding debt.

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