What does the chart show? 

This chart shows the foreign currency reserves for the UK, Japan, and China in US Dollar terms. Foreign currency reserves are very important to a country’s economic health. Commodities are often priced in dollar terms and so dollars are needed to purchase them. When trading with foreign nations, having a store of their currency is necessary to purchase their goods. Central Banks hold foreign currencies that importers can exchange into local currencies to import foreign goods. A country with a negative balance of trade needs foreign currency reserves to pay for its imports. The store of foreign currencies can also be used by a central bank to stabilise the price of their own currency. If a local currency is devaluing heavily against another, then a central bank can sell their reserves of the foreign currency bringing the price of its own currency up. Japan and China are both examples of countries that have recently manipulated their own currencies in some way. Their large reserves of over $1.1 trillion and $3 trillion respectively have allowed them to do this. In comparison, the UK’s foreign currency reserves sit at just $110 billion. 

Why is this important? 

Currency valuations have been thrown into the spotlight in recent months. Global uncertainty and the frontloading of interest rate hikes by the Federal Reserve have led to significant inflows of capital into the US. The US Dollar has surged in value at the expense of other currencies reaching parity with the Euro for the first time since 2002 and pushing the value of the Yen down to as low as ¥145 per dollar. In the UK, the release of new Chancellor Kwasi Kwarteng’s so called ‘mini-budget’ saw the value of the Pound drop sharply to as low as $1.033. Although the value of the pound has been gradually falling in recent months, the sharp drop is unlike anything that the Pound has experienced before. There is now an expectation that some sort of intervention may be needed to stabilise the currency. The Bank of England (BoE) has already shown its willingness to intervene in markets to limit volatility with its purchases of long-term gilts. However, when compared to historical examples of currency interventions, the BoE’s options are limited. Just last week, the Japanese government intervened to halt the slide in the value of the Yen. In a one-off move, a bulk sale of Dollars for Yen saw the price of the Yen rise to ¥141 from ¥145 against the Dollar. Although the interest differential between the two countries means that downward pressure on the Yen is maintained, the move could offput some speculators who have helped drive down the value of the Yen. China’s vast foreign currency reserves have allowed it to limit volatility in its own currency through moderate levels of intervention. The UK’s large current account deficit and smaller currency reserves mean that they are less able to intervene in the same way that Japan and China have in the past. Instead, the BoE may resort to other measures. With the next Monetary Policy Committee meeting not until November, markets have priced in an unprecedented 150 basis points rise of the BoE rate with some suggesting there could be an emergency rate rise before then. A dramatic rise in rates increases is likely to contribute further to an economic slowdown further down the line. Already facing high inflation and now battling the risk of a spiralling currency, the BoE has a difficult task ahead.