Money in Motion

Guess Whose Currency Buying Has Stalled?

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China's central bank reserves are barely growing, and that is bad news for the euro.

The euro has more than its share of home-grown problems. Now comes another from the other side of the world: the People's Bank of China.

China's central bank was increasing its reserves at an impressive clip from 2001 until last September, according to Simon Derrick, chief currency strategist at Bank of New York Mellon.

But then the euro zone crisis intensified and China's economy began to slow. On top of that, the U.S. shifted from outright quantitative easing to Operation Twist, and with the dollar's slide largely stopped China had less of a need to rebalance its dollar holdings.

All in all, by Derrick's accounting, "between June of last year and June of this year China’s FX reserves grew by just 1.32%. In contrast, the average year-on-year growth rate since 2001 has been a little over 30%," he wrote in a note to clients. Even the slowest quarters saw growth well above the rate of the last year.

Why should you care? Because for the last several years, moves by central banks to diversify their holdings— and thereby increase their holdings of currencies like the euro—have been important drivers of currency performance.

When that process slows, Derrick says, it's bad for the euro. "A continued lack of reserve growth in the months ahead should naturally spill into low levels of demand for the EUR for diversification purposes.

In other words, the natural decline that first began to emerge in EUR/USD at the start of September as the demand from reserve diversifiers began to wane should continue for some time to come."

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