Amid a crisis of confidence in the pound, the UK’s forex reserves are getting more attention than usual. But what are they, and what do they tell us about the economy?
This chart shows the UK government’s net foreign currency and gold reserves as recorded by the Office for National Statistics. It includes reserve assets and repo liabilities, as well as the UK’s automatic drawing rights on the IMF.
What are they?
Foreign exchange reserves are the sum of all the foreign currency assets held by a country's central bank. They can include gold, marketable securities denominated in foreign currencies like sovereign bonds, corporate bonds and equities, foreign currency deposits and special drawing rights at the IMF.
They are used to balance a nation's payments, help influence the foreign exchange rate and to support confidence in financial markets. Basically, they are the bank's back-up funds.
The UK's meager forex reserves are made up of dollar, euro and gold, with more than three-quarters in hard cash. The rest is in the form of IMF special drawing rights and the Reserve Tranche Position (RTP), which is the UK's share of the unused quota at the IMF.
These figures are reported in IMF's International Investment Position and appear as 'Reserve Assets' within the table 1.2J. The data is also available in the UK's Balance of Payments and within the quarterly 'International Investment Position' publication from ONS.
In June 2023, UK forex reserves were 154,759.9 million US dollars. CEIC estimates exclude the Bank of England's foreign currency assets, which can be used for monetary policy purposes, and other reserve assets, including repo claims, swap positions and foreign currency forwards.
The US has the world's largest foreign exchange reserves, followed by Japan and Russia. China, which has a rapidly growing economy, is close behind with its reserves increasing to over $5 trillion in the last year or so. However, the UK has a very low level of reserves and it has never been a priority for the Bank of England to build them up. This has been a major contributing factor to the recent slide in the value of the pound.
How do they work?
For central banks, reserves are a way to protect themselves from shocks to the economy. They are usually held in the form of gold or foreign currency, and can also include marketable securities like government bonds, corporate bonds, equities and foreign exchange derivatives. Reserves can be used to buy foreign currencies at a discount, or to sell them at a profit. They can also be used to cover short-term borrowing needs.
When the UK’s forex reserves are low, it is a sign that the country’s economy may be under stress. The Bank of England can use its reserves to support the currency, or to take positions in the foreign exchange markets to help manage inflationary pressures. In addition, the Bank can use its forex reserves to purchase assets, such as stocks and real estate, that are not available on the domestic market.
The Bank of England’s forex reserves are made up of cash, gold and other marketable securities. They are offset by debt instruments such as repo agreements and foreign exchange forwards.
In the past, the pound sterling was the reserve currency of choice for many countries, but its status has declined since the end of the gold standard. The pound was once the world’s dominant reserve currency, holding more than 55% of the global official reserves in 1950 (Schenk, 2010). zigzag
While it is not common for central banks to use their forex reserves to intervene on the foreign exchange market, they do have the option. They can also buy their own currency on the foreign exchange market, which can be a quick and inexpensive way to prop up a weakening currency. This strategy has worked in the past, but it is not always successful.
The United Kingdom’s forex reserves were valued at 154,759.9 million USD in June 2023. Get more data on the UK Economy and other key indicators at our digital data assistant. We bring you the most important economic news and insights, directly from the source. Join our community of accountants and finance professionals to receive the latest updates, tools and resources that are curated specifically for your sector.
Why do they matter?
A country’s foreign-exchange reserves are an important tool that can help stabilize its currency and provide a safety net in times of crisis. In the event of a sudden depreciation, a country’s reserve assets can be used to purchase its own currency on the markets and restore its value. This is a common strategy that central banks use to help support the local economy and preserve their reputation in global financial markets.
In the case of the UK, its foreign-exchange reserves currently stand at just under a month’s worth of imports. That’s a relatively low level for a developed nation. However, the pound has been falling in recent weeks and the Bank of England hasn’t done much to stop it.
As a result, the Bank’s reserve position has been receiving more attention than usual. The Bank of England’s next update on its forex reserves will be in early October.
The Bank of England’s current forex reserves are composed of a mixture of hard cash and bonds. The majority of its reserves are held in US dollars and euros, but the Bank also holds special drawing rights (SDRs) from the International Monetary Fund and marketable securities like treasury bills and government bonds.
While the Bank of England doesn’t hold a lot of foreign-exchange reserves, it does have more than enough to meet its monetary policy objectives. It has been able to achieve this by a combination of quantitative tightening, the maturity of the Term Funding Scheme and incentives for SME lending.
Eventually, however, the Bank will run out of cash. At that point, it will have to sell off some of its holdings in order to replace them. Whether this will happen anytime soon is unclear, but it is possible that the Bank may begin to sell off its SDRs in 2022 Q4. This would free up some of the Bank’s holdings and could potentially reduce its reserve demand.
How do they affect the pound?
Foreign currency reserves are cash and other assets – normally gold – held by central banks or monetary authorities. They are used to support their monetary policy goals of controlling inflation. Reserves also act as a buffer against changes in market sentiment, which can lead to volatile exchange rates. In the United Kingdom, the Bank of England manages the country’s foreign currency reserves. Its foreign currency assets are made up of gold, foreign currency deposits and IMF special drawing rights. It also maintains positions in money and repo markets to keep cash accessible.
The UK’s international reserves are currently dominated by the dollar and the euro, but there are signs that other currencies could be catching up. The Japanese yen has grown, and the Swiss franc is also seen as a relatively safe haven. As the global political and economic environment becomes more fractured, a greater number of reserve currency options for central banks seems like a good idea.
Reserves are used to buy a currency on the foreign exchange market in order to stabilize its value. They can be purchased in a variety of ways, including by central banks and commercial banks. In the case of the UK, its international reserves are mostly composed of foreign currency deposits and IMF special drawing rights. They are also bolstered by trading in money and repo markets.
One of the most notable cases of a country’s forex reserves being used to protect the pound was in 1992. Black Wednesday was a massively damaging event that forced Britain out of the European Exchange Rate Mechanism (ERM). It was a huge waste of resources, and it damaged the reputation of the U.K. Government for effective economic management. However, it did save the economy from more serious problems later on.
The pound has recovered since then, and its international reserves are growing. However, the recent turmoil in the EU has sparked new concerns about the UK’s financial stability. This will put more pressure on the Reserve Bank of England to act. The next update on the pound’s reserve position is due in early October.