Bank of Italy says switch to pounds doesn't anticipate dollar crash

From Reuters
Thursday, August 3, 2006

http://asia.news.yahoo.com/060803/3/2nzjk.html

ROME -- The Bank of Italy said on Thursday that its action last year in slashing dollar reserves and switching heavily into the British pound was not motivated by any expectation of a slide in the dollar.

A senior BOI official denied a report in Britain's Telegraph newspaper that cited an Italian official saying the BOI had been acting in advance of an expected dollar fall linked to the end of the Federal Reserve's campaign of monetary tightening.

"Our expectations of Fed policy did not play any role," the official, who asked not to be named, told Reuters.

"We base our reserve decisions on complex models that incorporate a wide range of factors, not on near term currency expectations," said the official, who asked not to be named.

He also said it would "foolish" for the BOI to base its moves on predictions of forex rate movements one or two years ahead.

A report by the central bank this week showed it had cut the share of its dollar reserves in 2005 to 63 percent from 84 percent and trimmed reserves in the Japanese yen, while holdings of sterling rose to 25 percent from zero in 2004.

The Bank of Italy official said it was implausible to imagine, as implied by the Telegraph article, that the BOI would take its currency reserve decisions in 2005 on the expectation of what Fed interest rate policy would be 1 1/2 years later.

The official pointed out that the reserve switch reflected in this week's data was "old," as it referred to 2005. He declined to disclose what reserve decisions had been put into effect so far this year.

Nonetheless, foreign exchange strategists said the BOI's data is part of a trend away from the dollar, which has been long forecast to tumble under the weight of the massive U.S. current account deficit and expectations that rate tightening by the Federal Reserve is nearing its end.

Central banks, with more than $4 trillion of forex reserves, are key players in the $2 trillion-a-day currency market. The emerging market economies of Asia and the Middle East have already started lowering their dollar exposure.

Sweden too has joined in, while the European Central Bank's U.S. dollar holdings were broadly stable from mid-2004 through mid-2005 after falling to 85 percent of its 41 billion euros from just under 90 percent in 1999. No current data are available.

Currency strategists said they were watching closely which currency picked up the mantle, as the move away from the dollar as the favoured global currency gathered pace.

"The broad point about the reserve story is that it is about diversification out of dollar given the risks. The pound seemingly is increasing in prominence as an alternative," said Tim Fox, forex strategist at Dresdner Kleinwort in London.

Whether sterling will retain its appeal, however, depends on its yield advantage as central banks weigh the direction of interest rates, he added.

Worries about central banks diversifying their reserves away from the dollar have dogged the U.S. currency in the past few years.

There is particular fear that massive dollar stockpiles that Asian central banks have built up to prevent their domestic currencies from strengthening may not be sustainable in the light of the U.S. current account deficit.

China's reserves, the world's biggest, have swelled by more than $120 billion in the first six months of the year to $941.1 billion, as Beijing's tight control of the yuan forced it to buy dollars coming in from trade surpluses and investment.

Countries such as the United Arab Emirates and Russia have said they are shifting out of dollars and into other currencies like the euro.