The international role of the euro, June 2018

This 17th annual review of the international role of the euro published by the ECB is an interim version that presents a concise overview of developments in the use of the euro by non-euro area residents.

This report covers developments in 2017 and early 2018. This period was characterised by a strong and broad-based growth momentum in the euro area economy as well as by the continued impact of the ECB’s asset purchase programme. These developments affected the international role of the euro, which showed signs of broad stabilisation, although developments differed across dimensions of the international use of the euro. On the one hand, the shares of the euro in global payments and in global foreign exchange settlements increased. Portfolio inflows into euro area equities were strong. On the other hand, a number of indicators tracked in this report show the share of the euro as having declined. This was particularly the case for outstanding amounts of international debt securities and international deposits and for shipments of euro banknotes to destinations outside the euro area. Overall, the euro remained unchallenged as the second most important currency in the international monetary system.

The international role of the euro is primarily determined by market forces. The Eurosystem neither hinders nor promotes the international use of the euro. At the same time, the ECB will continue to monitor developments and publish information on the international role of the euro on a regular basis.

Mario Draghi
President

In 2017 and early 2018, the strong and broad-based growth momentum in the euro area economy as well as the continued impact of the ECB’s asset purchase programme were among the main developments affecting the international role of the euro.

In this environment, the international use of the euro showed signs of broad stabilisation (see Table 1). For instance, the shares of the euro in global payments and in global foreign exchange settlements increased noticeably in the second quarter of 2017. Portfolio inflows into euro area equities were as high as they ever have been since the advent of the euro in 1999, on the back of the growth momentum in the euro area economy, which supported the interest of foreign investors in euro area equity markets.

However, developments also reflected the strengthening of the euro exchange rate over the review period. For example, the share of the euro in official holdings of foreign exchange reserves increased slightly, when measured at current exchange rates. By contrast, adjusting for exchange rate valuation effects, the share of the euro in global foreign exchange reserves decreased.

Moreover, other indicators tracked in this report showed the share of the euro as having declined over the review period. This was particularly the case for outstanding amounts of international debt securities and international deposits and for shipments of euro banknotes to destinations outside the euro area. The decline in foreign demand for euro banknotes might reflect a range of factors, including financial innovation, declining geopolitical uncertainty in euro area neighbouring regions and global efforts to combat tax and financial crime. Moreover, this suggests that improving sentiment vis-à-vis the euro and stronger euro area growth, which drove a large share of the strengthening of the euro exchange rate in 2017, have not so far been reflected across all indicators of the international use of the euro.

Moreover, some other persistent factors continued to weigh on the international role of the euro. One such factor is the increasing importance of emerging market economies as issuers of foreign currency debt since the global financial crisis. This shift contributes to explaining the decline in the share of the euro in international debt securities markets despite the historically low levels of interest rates prevailing in the euro area since many emerging markets have a traditional preference for the US dollar. Another factor is the ongoing deleveraging by euro area banks, which have cut lending abroad to restore their capital ratios, as exemplified by the fact that the stock of cross-border loans in euro remains well below its peak prior to the global financial crisis of 2007-09.

Overall, a new index of the euro’s international role – computed as a simple arithmetic average of the share of the euro across a broad range of indicators – remained close to historical lows in the review period, notwithstanding the aforementioned signs of broad stabilisation (see Chart 1). As noted in last year’s edition of the report, while the euro remains unchallenged as the second most important currency in the international monetary system (see Chart 2), deeper and better connected European capital markets, for instance as a result of moving towards an EU capital markets union, as well as a completed banking union, may contribute to the depth and liquidity of euro area financial markets. As an indirect result, this could also foster the international standing of the euro.^[1]

2.1 Use of the euro as an international reserve, payment and investment currency

2.1.1 The euro as an international reserve currency

The share of the euro in global official holdings of foreign exchange reserves rebounded in 2017, albeit from low levels. At current exchange rates, the share of the euro in globally disclosed holdings of foreign exchange reserves increased by a full percentage point to 20.1% in the fourth quarter of 2017 from 19.1% at the end of 2016 (see Chart 3 and Table A1). The share of the euro started to increase noticeably in the second quarter of 2017. The share of the US dollar fell in tandem, by almost three percentage points, from 65.3% at the end of 2016 to 62.7% in the fourth quarter of 2017, standing at a four-year low.

These developments do not necessarily point to active rebalancing of official reserve portfolios away from the US dollar into the euro. It has been suggested that the weakness in the US dollar in the foreign exchange market in 2017 might reflect decisions by official reserve managers to shift a share of their holdings away from US dollar-denominated assets into other currencies, such as the euro.^[2] This interpretation is not borne out by the data, however, insofar as the rise in the share of the euro in global foreign exchange reserves last year reflected the strengthening of the euro exchange rate against the US dollar. Adjusting for exchange rate movements, the share of the euro in globally disclosed holdings of foreign exchange reserves fell by almost a full percentage point relative to the end of 2016, while the share of the US dollar lost around half a percentage point (see Chart 4). This therefore suggests that the nominal increase in the share of the euro in global foreign reserve portfolios should be interpreted as a sign of passive diversification (i.e. through valuation changes) on the part of official reserve holders, not necessarily as active diversification through outright euro purchases.

Turning to other major currencies, the share of the yen in global foreign exchange reserves increased by almost a full percentage point over the review period (at both current and constant exchange rates). It is unclear whether this increase is due to the yen’s traditional status as a safe haven. Global risk aversion, as measured by the VIX index – a standard market metric of implied volatility in US equity prices – remained low in 2017 and surged briefly in February 2018. Moreover, despite uncertainties raised by negotiations about the United Kingdom’s withdrawal from the European Union, the share of the pound sterling in global foreign exchange reserves remained broadly stable in 2017. As noted in last year’s report, according to evidence gathered in a survey of 80 official reserve managers, collectively managing around half of the world’s USD 12 trillion in reserves, more than 70% of the respondents indicated that Brexit had not led them to reassess their views of the pound sterling in the long run.^[3]

The share of non-traditional reserve currencies^[4] in global foreign exchange reserves rose further in 2017, standing about half a percentage point higher than at the end of 2016 at current exchange rates (as against 0.3 percentage point at constant exchange rates; see Chart 5). Official reserve managers increased their exposures to the Australian dollar and the Canadian dollar, whose shares in global foreign exchange reserves rose, in an environment of rising oil prices, which traditionally benefits “commodity” currencies.^[5] Since the fourth quarter of 2016, the IMF separately identifies official reserve holdings denominated in renminbi given its inclusion in the Special Drawing Right (SDR) basket. These holdings stood at a low level, i.e. slightly above 1% of global foreign exchange reserves, which reflects, to some extent, the fact that the Chinese currency is still not fully convertible, not least after the temporary reintroduction of capital controls in China in 2016 which, since then, have been gradually lifted.

Central bank reserve managers point to higher interest rates as the main risk to their portfolios in 2018.^[6] About 60% of the respondents of a survey of 79 central bank reserve managers responsible for about half of global foreign exchange reserves identified rising interest rates as the main pressing risk going forward, insofar as a large share of their portfolios is made up of debt securities whose valuations are particularly sensitive to interest rate movements (see Chart 6). A large share of the reserve managers indicating that this risk was the most pressing was from emerging market economies. Almost 20% of the reserve managers (in particular those in advanced economies) identified overvalued asset prices as a major challenge. Finally, reserve managers were increasingly confident about the role of the renminbi as a reserve currency. As many as 29 reserve managers contributing to the survey expected the Chinese currency to account for 10-20% of their portfolios by 2020.

2.1.2 The euro as an international payment currency

The share of the euro in global payments increased last year. Data collected by the Society for Worldwide Interbank Financial Telecommunication (SWIFT) – the world’s leading provider of secure financial messaging services – show that the share of the euro in value terms in global payments increased from about 31% in 2016 to almost 36% in 2017 (see Chart 7). These data may overestimate the share of the euro, however, to the extent that they include intra-euro area payments. But estimates available from SWIFT for two years (2015 and 2017) which exclude intra-euro area payments confirm that the share of the euro is in the order of 39% and has been rising (see Chart 8).^[7] The US dollar remained the most commonly used currency in global payments in 2017 (accounting for about 40% of the payments in question), but its share fell by about two percentage points. Exchange rate valuation effects may again contribute to explaining these developments. Payments in pounds sterling and yen remained broadly stable. The share of the renminbi continued to fall, which might reflect the capital controls that China introduced in 2016 and started to remove only recently, suggesting that the renminbi’s ascent as a currency for global international payments has paused.^[8]

2.1.3 The euro as an international investment currency

Portfolio inflows into euro area equities reached record highs in 2017. Balance-of-payments data suggest that net purchases of euro area equities by foreign investors quadrupled in 2017 relative to 2016, to reach almost €450 billion in February 2018 (see Chart 9). Never before in the history of the euro area have portfolio equity inflows been so high. Strong and broad-based growth momentum in the euro area economy supported equity market valuations and interest from foreign investors. In contrast, foreign investors continued to retreat from euro area bonds. Against the background of the ECB’s asset purchase programme (APP), foreign investors were net sellers of approximately €210 billion worth of debt securities in 2016, of which €200 billion were bonds. As in 2016, the decline in demand for euro area bonds partly reflected the low yields prevailing in the euro area in the wake of the APP, which might have encouraged some investors to rebalance their portfolios towards high-yielding bonds denominated in other currencies seen as close substitutes.^[9]

2.2 The euro in global foreign exchange markets

The euro exchange rate strengthened markedly over the review period. Between May 2017 and April 2018, the euro gained about 11% against the US dollar and about 8% in nominal effective terms against the euro area’s 38 major trading partners (see Chart 10). Stronger global investor sentiment towards the euro was an important determinant of the appreciation of the euro against the US dollar. In line with this interpretation, the appreciation started in late April 2017, i.e. following national elections in one large euro area country, while non-commercial (also known as “speculative”) positions in euro futures contracts moved from net short to net long (see Chart 11).

Model-based estimates suggest that the appreciation of the euro against the US dollar, in particular, reflected a combination of stronger investor sentiment towards the euro, stronger euro area growth and shifts in market expectations about prospective monetary policy stances on both sides of the Atlantic. Model-based estimates obtained from a Bayesian vector autoregression (BVAR) model where structural shocks driving the USD/EUR exchange rate are identified via sign restrictions suggest that the euro’s appreciation against the US dollar over the review period can be largely ascribed to stronger investor sentiment towards the euro, to the robust expansion of the euro area economy and to changes in market expectations about the monetary policy stance in the United States relative to that in the euro area (see Chart 12). In particular, the appreciation of the euro against the US dollar in the third quarter of 2017 was driven by a combination of these three factors, each contributing about a third to the overall appreciation of the euro. Over the whole review period, all three factors played a role too, although stronger sentiment was consistently the most important factor. That stronger sentiment vis-à-vis the euro and stronger euro area growth were important drivers of the strengthening of the euro over the review period is also in line with the strong interest of foreign investors in euro area equities in 2017 (as noted in Section 2.1.3).

Evidence on the role of the euro in the foreign exchange market based on quantities points to similar conclusions. In the absence of updated data from the triennial survey conducted by the Bank for International Settlements – which was last released in December 2016 and was commented upon in last year’s report – quantity-based evidence on the role of the euro in the foreign exchange market can be gleaned from data on foreign exchange transactions settled in the Continuous Linked Settlement (CLS) system, operated by a specialised financial institution providing settlement services to its members in the foreign exchange market (see Chart 13).^[10] Although the data are volatile, they indicate that the share of the euro in global foreign exchange settlements increased noticeably in 2017, by about 4 percentage points to about 38% over the past year. The pick-up in settlements was particularly visible around April and May 2017. That being said, the US dollar remained the leading currency in the foreign exchange market by a wide margin, being involved in about 91% of all settlements in January 2018, while the euro remained the second most actively settled currency.

2.3 Use of the euro in international debt and loan markets

2.3.1 The euro in international debt markets

The share of the euro in the stock of international debt securities declined slightly in 2017 (see Chart 14 and Table A4). At constant exchange rates, the share of the euro declined by more than half a percentage point, to 23.4%. It remains well below the levels prevailing before the onset of the global financial crisis.^[11] The US dollar further expanded its dominant role in international debt markets, with its share increasing by over a percentage point, to 62.2%. Since the peak of 2004, the share of the euro has declined by about eight percentage points, while that of the US dollar has increased by close to 19 percentage points.

Developments in the issuance of international debt point to a slight increase in the role of the euro, however. Developments in issuance reflect more clearly recent trends in international debt markets than developments in stocks. By this metric, the share of the euro stood at 21% in the fourth quarter of 2017, up from 20% in the fourth quarter of 2016 (see Chart 15). Debt issuance in euro by emerging market borrowers continued to decline, while issuance by borrowers in advanced economies increased (see Chart 16).

The volume of euro-denominated foreign currency debt issuance remains well below pre-global financial crisis peaks. In 2017 non-euro area residents issued USD 800 billion worth of euro-denominated debt, which is slightly more than half of the volume issued in 2007 (USD 1.5 trillion). US dollar-denominated debt issuance by non-US residents also sharply declined after the global financial crisis. However, it recovered quickly, reaching almost USD 2.7 trillion in 2017, an increase of 40% relative to the pre-crisis peaks. Dynamic borrowing by emerging market issuers, which have sought to take advantage of historically low levels of interest rates, is seen as one reason explaining the significant increase in US dollar-denominated issuance in the past few years. ^[12]

The preference of emerging market borrowers for the US dollar as a funding currency is one persistent factor behind the decline in the share of the euro in international debt markets. As noted in earlier issues of the report, borrowers in advanced economies, notably the United States and the United Kingdom, have historically accounted for the bulk of international debt issuance (see Chart 17). The increase in the euro’s share in international debt markets prior to the global financial crisis largely reflected the rise in international debt issuance in these two economies. Since the global financial crisis, however, international debt issuance by emerging market economies in Asia, Latin America and the Middle East – which trade significantly with the United States or anchor their currencies to the US dollar and therefore have a traditional dollar orientation – has been particularly strong. The share of emerging market economies in euro-denominated international debt issuance remained below 10% in 2017, as against one-third in US dollar-denominated international debt issuance.

Private borrowers remained the main issuers of euro-denominated international bonds. As in previous years, financial institutions were active borrowers in euro-denominated international bond markets, accounting for half of total issuance (see Chart 18). Borrowers from the construction and manufacturing sector accounted for a quarter of total issuance, followed by borrowers in the transportation and trade sector, with about 17%. Sovereigns and borrowers in the mining sector took up the residual, i.e. less than 10% of total issuance.

A development supportive of the use of the euro as a funding currency in international debt markets might be the gradual decline in the cost of synthetic US dollar borrowing. An important indicator of the appeal of the euro as an international funding currency is the cross-currency swap (CCS) basis. As noted in last year’s report, the CCS basis is important because it determines the euro’s attractiveness as an international funding currency for the synthetic issuance of US dollars. A negative CCS basis is equivalent to paying a premium for borrowing US dollars “synthetically” via another funding currency, such as the euro. The operation consists of borrowing euro and swapping the proceeds by means of a CCS contract to hedge against foreign exchange risk, with the basis being the premium over the price of direct US dollar borrowing in the wholesale money market.^[13] The price in question may be e.g. the LIBOR for US dollars. Since the outbreak of the global financial crisis a decade ago, the CCS basis has remained large and negative, albeit volatile. This has discouraged synthetic US dollar issuance via currencies such as the euro and encouraged direct issuance of US dollar-denominated bonds. However, the CCS basis across different maturities declined in the course of 2017. For instance, at the five-year maturity, the basis declined from about 50 to about 30 basis points (see Chart 19), while at the three-month maturity, it narrowed from about 60 to about 10 basis points amid considerable volatility.^[14] A smaller CCS basis lowers the premium paid for synthetic dollar borrowing and enhances the attractiveness of the euro as a funding currency. At the same time, the spread between LIBOR and the overnight indexed swap rate, known as LIBOR-OIS spread, has increased strongly, making the price of US dollar short-term funding more expensive. Market commentators have ascribed the decline in the CCS basis at short-term maturities to recent adjustments in US tax regulation.^[15]

2.3.2 The euro in international loan markets

The share of the euro in international loan markets remained stable in 2017. The share of the euro in the stock of cross-border loans stood at 23.2% at the end of the review period, a slight decline relative to end-2016 (see Chart 20 and Table A8). The decline in the share of the euro since early 2013 has reflected inter alia the ongoing deleveraging process of euro area banks, including efforts to reduce exposures to foreign loans denominated in the euro.^[16]

In line with this, recent evidence suggests that the global decline in cross-border banking since 2007 did not reflect a broad-based retrenchment in international lending, which some observers referred to as “financial deglobalisation”. Instead, the decline appears to have been restricted to European banks, which shed assets abroad after 2007 to restore capital ratios and cut lending overseas.^[17] The scale of the deleveraging is epitomised by the fact that the stock of cross-border loans denominated in euro still remains short of its pre-global financial crisis peaks (see Chart 21). This stands in contrast to the stock of cross-border loans in US dollars, which recovered quickly after 2007-09 and now stands about 20% higher than pre-crisis peaks (see Chart 22)

2.4 Other indicators of the euro’s international use

Net monthly shipments of euro banknotes to destinations outside the euro area point to a further decline in foreign demand for euro banknotes in 2017 (see Chart 23).^[18] The decline may reflect several factors. First, weaker foreign demand for euro banknotes might be in line with the effects that financial innovation, new transaction technologies, changes in payment infrastructures and consumer preferences have on the demand for cash and its use, as compared with other methods of payment. Second, perceptions of declining geopolitical uncertainty and increasing macroeconomic stability in EU neighbouring regions might also have redirected demand away from euro banknotes, which are traditionally used for hoarding or as a safe haven in these regions. The announcement by the ECB on 4 May 2016 that it would discontinue production and issuance of €500 banknotes might have reduced demand for this denomination, although it remains legal tender. Global efforts under the auspices of the G7 and the G20 to combat tax and financial crime might have been an additional factor.

In terms of destinations, entities in euro area neighbouring countries were the main purchasers of euro banknotes, including the United Kingdom in the EU, Switzerland in the region Western Europe (non-EU) and Russia in the region Eastern Europe (non-EU) (see Chart 24). Euro banknotes were mainly imported from euro area neighbouring countries too, first and foremost from eastern EU countries and Turkey.

The share of the euro in outstanding loans declined further in central, eastern and south-eastern Europe (see Table A12). As noted in last year’s edition of the report, this may reflect local authorities’ efforts to promote the use of domestic currencies to mitigate financial stability risks raised by unofficial euroisation. The share of the euro in foreign deposits also decreased moderately in some of these countries (see Table A13).

Lastly, the share of the euro as an invoicing or settlement currency for extra-euro area trade in goods remained broadly stable for exports, while declining slightly for imports. In 2017, about 57% of extra-euro area exports and 45% of extra-euro area imports of goods were invoiced in euro (see Table A10). These shares were slightly higher for extra-euro area trade in services, with about 63% of exports and 53% of imports being invoiced in euro in 2017.

3.1 The euro in global foreign exchange reserves and exchange rate anchoring

3.2 The euro in international debt markets

3.3 The euro in international loan and deposit markets

3.4 The euro in international trade in goods and services

3.5 The euro as a parallel currency: the use of euro-denominated bank loans and deposits in countries outside the euro area

3.6 Summary