Watch out for Osborne’s foreign currency plans

Prof Philip Booth writes for City AM

A few ears pricked up on budget day when George Osborne announced a surprising and potentially expensive plan to rebuild Britain’s foreign currency reserves.

There are two methods of executing this plan. The first is to print sterling to buy foreign currency. This could be regarded as quantitative easing (QE) by another method. Indeed, it might have been an effective way to execute QE in 2009, though it would probably have caused a riot in the Eurozone as other governments – ignorant of the fact that a fall in the exchange rate caused by loosening monetary policy brings no lasting effect – would have accused us of indulging in competitive devaluations.

The second method is that the Debt Management Office (DMO) or possibly the Bank of England (BoE) could issue bonds and use the funds raised to buy foreign exchange reserves for the government. This is expensive. The government pays interest on the bonds and earns no interest on the foreign exchange. It is possible that Osborne is intending that we buy foreign currency bonds rather than cash reserves. In that case, interest would be earned on those bonds but there would then be inter-governmental credit risk: today’s high quality asset is not necessarily tomorrow’s.

One gets the impression from the debt management reports that Osborne proposes the second route – however, it is possible that they were written before he decided to make the announcement.

Read the rest of the article on the City AM website.

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