The international role of the euro –2017 report

Arnaud Mehl

5 October 2017

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Euro remains second most important currency

2

Sources: BIS, IMF, SWIFT, and ECB calculations.Note: Data as at end-2016 or latest available.

Snapshot of the international monetary system (percent of total)

63.059.1

43.8 42.1

64.0

22.0 21.315.7

31.3

19.7

0.4 2.0 1.7 1.12.6 3.6

10.8

3.4 4.2

0

20

40

60

Internationaldebt

Internationalloans

Foreignexchangeturnover

Global paymentcurrency

Foreignexchangereserves

USD

EUR

Renminbi

JPY

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Euro lost some ground in 2016, albeit not uniformly

3Sources: BIS, Dealogic, IMF, national sources and ECB calculations.

Indicator Latest Comparison period

Difference (percentage

points)

Stock of global foreign exchange reserves with 19.7 19.4 0.3 known currency composition, at constant exchange rates (Q4 2016) (Q4 2015)

Oustanding international debt securities:narrow measure, i.e. excluding home currency issuance, 22.0 22.4 -0.4 at constant exchange rates (Q4 2016) (Q4 2015)

Oustanding international loans:all cross-border loans, excluding interbank loans, 21.3 21.5 -0.2 at constant exchange rates (Q4 2016) (Q4 2015)

Oustanding international depositsall cross-border loans, excluding interbank loans, 23.4 23.4 0.0 at constant exchange rates (Q4 2016) (Q4 2015)

Foreign currency-denominated debt issuance 20.4 24.8 -4.4 at current exchange rates (2016) (2015)

36.1 37.6 -1.5

(2016) (2015)

39.6 41.2 -1.6

(2016) (2015)

32.5 33.0 -0.5

(2016) (2015)

56.1 57.4 -1.3

(2016) (2015)

47.3 47.5 -0.2

(2016) (2015)

17.1 18.6 -1.5

(Q4 2016) (Q4 2015)

Foreign currency-denominated deposits in CESEE countries, as a percentage of total deposits, at current exchange rates¹

Invoicing of goods exported from the euro area to non-euro area countries, at current exchange rates

Invoicing of goods imported to the euro area from non-euro area countries, at current exchange rates

Foreign holdings of euro area debt denominated in euro (as a percentage of total euro-denominated debt)

Share of the euro(percentages, unless otherwise indicated)

Daily foreign exchange trading (settled by CLS), annual averages, at current exchange rates, as a percentage of foreign exchange settlement

Foreign currency-denominated loans in CESEE countries, as a percentage of total loans, at current exchange rates¹

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• Heightened non-economic risks affected euro’s international role in 2016 and early 2017

o Geopolitical developments, euro area elections, uncertainty created by Brexit, new US administration, etc.

• Euro continued to lose some ground, albeit not uniformly so

o Share down for most indicatorso Share up in global FX reserves & payments

• Euro remained unchallenged as 2nd most important currency globally

• Capital Markets and Banking Unions could buttress euro area financial markets’ depth and liquidity & indirectly the euro’s international standing

Conclusions

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• The euro and the geography of the foreign exchange market

o Bulk of FX transactions in euros initiated outside the euro area, notably in the City of London; technological change, notably electronic trading, has major implications for the geography of FX trading

Special features

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Key role of the City of London for FX trading in euros

6

Sources: BIS and ECB calculationsNotes: Evolution of the share of selected countries in global foreign exchange transactions in euros, 2001-2016.

UK share of global FX trading 10 percentage points up since 2001(percentages)

Bulk of euro FX trades initiated outside the euro area, notably in the City of London(percentages)

Sources: BIS and ECB calculations.Notes: Share of selected countries in global foreign exchange transactions in euros, 2016. The data include spot, forward, swap and other transactions. They are adjusted for local inter-dealer transactions.

Euro area15.8

U.K.43.4

U.S.19.4

Singapore & Hong Kong 6.8

Switzerland2.7

Rest12.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

2001 2004 2007 2010 2013 2016

Euro areaU.K.U.S.

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Identification of technological shocks

The world’s undersea fiber-optic cable network now

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Big effect of technology on geography of FX trading

8

Fiber-optic cable connections cause countries to lose trading in their currency to major financial centers, like London(y-axis: share of trading of currency i in major financial centres in percentages; x-axis: time zone difference in hours from country i to closest major financial center)

Source: Eichengreen, Lafarguette and Mehl (2016).Notes: Estimated impact of submarine fiber-optic cable connections on the effect of time zone distance on the geography of foreign exchange trading.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

No cableCable

• Electronic trading erodes effects of standard spatial frictions (distance, liquidity, capital controls) that make trading more domestic

• Sizeable implications for geography of FX trading

• City of London big beneficiary as hub for fibre-optic cables

• Contribute to limit relocation of FX trading post-Brexit?

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• The euro and the geography of the foreign exchange market

o Bulk of FX transactions in euros initiated outside the euro area, notably in the City of London; technological change, notably electronic trading, has major implications for the geography of FX trading

• Violations in covered interest parity and the euro’s role as an international financing currency

o Ambiguous effect of non-standard monetary policy measures on role of the euro as an international financing currency: lower cost of borrowing euros offset by higher costs of swapping euros into dollars to hedge FX risk

Special features

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Increasing cost of swapping euros into dollars

10

Swap basis structurally negative since 2008; sharp increase since early 2014(basis points)

Source: Bloomberg.Notes: Cross-currency swap (CCS) basis of major currencies against the US dollar (three-month maturity). The CCS basis is quoted from the perspective of the US dollar-providing counterparty (who receives the basis).

-110

-90

-70

-50

-30

-10

10

EuroYenSterling

• Increasing awareness of counterparty risk

• Tighter limits to arbitrage (e.g. costly balance sheet expansion, margin calls, etc.)

• Regulation changes reducing USD liquidity supply in wholesale markets

• Low interest rate environment pushing demand for euro borrowing and FX hedging

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Neutral impact of ECB’s non-standard measures

11

A. Cost of borrowing euros down

(y-axis: percentages; x-axis: weeks)

Sources: Dedola et al. (2017), Haver, Dealogic and ECB staff estimates.Notes: Impulse response function of (A) 2-year interest rate differential (euro area-US), (B) 2-year CCS basis, and (C) euro-denominated international bond issuance to an exogenous shock in the ECB’s balance sheet relative to the Federal Reserve balance sheet. Prior announcements of non-standard monetary policy measures are used as instruments to identify innovations in central bank balance sheets due to liquidity supply shocks. The dynamic responses of variables (A), (B) and (C) to liquidity supply shocks are estimated with local projection methods à la Jordá (2005).

B. Cost of swapping euros into dollars up

(y-axis: percentages; x-axis: weeks)

C. Impact on international bond issues in euro neutral

(y-axis: USD mio; x-axis: weeks)

-150

-100

-50

0

50

100

150

200

250

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40-0.14

-0.12

-0.1

-0.08

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40

-0.25

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40

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• The euro and the geography of the foreign exchange market

o Bulk of FX transactions in euros initiated outside the euro area, notably in the City of London; technological change, notably electronic trading, has major implications for the geography of FX trading

• Violations in covered interest parity and the euro’s role as an international financing currency

o Ambiguous effect of non-standard monetary policy measures on role of the euro as an international financing currency: lower cost of borrowing euros offset by higher costs of swapping euros into dollars to hedge FX risk

• Unofficial euroisation in CESEE countrieso Tentative signs that local currency use is progressing in the

countries concerned, albeit slowly and largely restricted to loans and cash

Special features

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Slight rebound in euro share of global FX reserves

13

Sources: HSBC and Central Banking Publications.Note: Prospective determinants of global reserve allocations according to a central bank survey..

Survey evidence points to several concerns for reserve managers in 2017(percentage of respondents)

The share of the euro in global FX reserves rebounded slightly in 2016(percentages, at constant end-2016 exchange rates)

Sources: IMF and ECB calculations.Notes: Currency composition of global foreign exchange reserves whose composition is disclosed. The latest data are for the final quarter of 2016.

weakness/instability in the eurozone

34%

fear of major asset price corrections

30%

divergent monetary policies in

major centres16%

excessive dollar strength

15%

fear of world recession 2018-2019

5%

19

20

21

22

23

63

64

65

66

67

2012

2013

2014

2015

2016

USD (right-hand scale)

EUR (left-hand scale)

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Euro share up in global payments, down in FX turnover

14

Sources: HSBC and Central Banking Publications.Notes: Share of global OTC foreign exchange transactions, on a net-net basis.

.

The share of the euro in global foreign exchange turnover declined in 2016(percentages, in April of the corresponding year shown on the x-axis)

The share of the euro in global payments increased in 2016(percentages)

Source: SWIFT.Notes: Currency composition of global payments. Inbound plus outbound traffic. Based on value.

29.7 %

33.5 %

38.8 %

43.9 %

42.1 %

44.0 %

40.2 %

33.5 %

29.4 %

31.3 %

9.0 %

8.6 %

9.4 %

8.4 %

7.2 %

0 20 40 60 80 100

2012

2013

2014

2015

2016

USDEUR GBP

JPYCNYOther

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

2001 2004 2007 2010 2013 2016

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Decline in euro share of international debt securities

15

Sources: Bloomberg and ECB calculations.Notes: Cross-currency swap basis of the euro against the US dollar at the five-year maturity. The latest data are for 28 April 2017. .

FX swap costs increased markedly since mid-2014 hence discouraging use of euro as vehicle funding currency(basis points)

The share of the euro in the stock of international debt securities declined in 2016(percentages)

Sources: BIS and ECB calculations.Notes: Currency composition of the stock of international debt securities. The latest data are for the final quarter of 2016.

0%

10%

20%

30%

40%

50%

60%

70%

99Q4 01Q4 03Q4 05Q4 07Q4 09Q4 11Q4 13Q4 15Q4

EURUSD

JPYOther

-110

-90

-70

-50

-30

-10

10

2010 2011 2012 2013 2014 2015 2016 2017

EURJPYGBP

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Decline in foreign demand for euro area bonds & cash

16

Source: Eurosystem.Notes: Net monthly shipments of euro banknotes to destinations outside the euro area. The latest observation is for February 2017.

Foreign demand for euro banknotes declined in 2016(EUR billions; adjusted for seasonal effect)

Mixed developments in foreign demand for euro area securities in 2016 (equities up, bonds down)(volumes in EUR billions)

Sources: ECB and ECB calculations.Notes: Balance-of-payments statistics. The latest observation is for December 2016.

0

20

40

60

80

100

120

140

160

180

200

-4

-2

0

2

4

6

8

10

12

14

16

monthly shipments (left-hand scale)cumulative shipments (right-hand scale)

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De-euroization in Central, East & Southeast Europe?

17

Sources: Haver Analytics, national central banks and ECB staff calculations. Notes: Share of foreign currency deposits (outright or indexed) in total deposits.

Progress on deposit side more limited(percentages)

Signs of de-euroization in some countries on lending side(percentages)

Sources: Haver Analytics, national central banks and ECB staff calculations. Notes: Share of foreign currency loans (outright or indexed) in total loans.

0

10

20

30

40

50

60

70

80

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

Albania Bosnia andHerzegovina

FYR Macedonia Serbia Turkey

Foreign currencyEuro

0

10

20

30

40

50

60

70

80

90

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

2013

2014

2015

2016

Albania Bosnia andHerzegovina

FYR Macedonia Serbia Turkey

Foreign currencyEuro