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Global reserve managers upbeat on growth but worry about politics

87% of the reserve managers surveyed flagged further escalation in geopolitical conflicts as the biggest threat to this benign outcome

An escalation in geopolitical conflicts is the biggest risk to the global economy, according to central bank reserve managers, who are generally positive about the world's economic outlook, according to an annual survey released on Thursday.

The UBS Asset Management survey of 40 leading central banks that manage more than $15 trillion, about half of the world's foreign exchange (FX) reserves, found two thirds expected the global economy to return to moderate growth and inflation in the next five years.

It found that 71% expect U.S. headline consumer inflation to be between 2% and 3% in a year's time. The Federal Reserve has a 2% inflation target.

But 87% of the reserve managers surveyed flagged further escalation in geopolitical conflicts as the biggest threat to this benign outcome, and 41% said they are diversifying their investments more across regions and currencies fearing an escalation of tensions between the U.S. and China.

Gold has been a particular beneficiary of diversification, and its price has hit record highs. Among respondents, 24% had increased their gold exposure in the past year and 30% plan to do so in the coming year, although they also plan to raise bond allocations.

"The recent political decision to use profits from central banks of Russia’s frozen assets to finance Ukraine raises further the risk that FX reserves are no longer seen as a safe haven for central banks," said Massimiliano Castelli, head of strategy and advice at UBS Asset Management.

"Gold, an asset held by central banks largely for historical reasons linked to the time when it was a pillar of the global financial system, risks being brought back to life by ongoing geopolitical trends,” he added.

Around 260 billion euros ($281.40 billion) of Russian central bank funds are frozen worldwide, mostly in the EU.

The upcoming U.S. election could also add to tensions, according to the survey, with 94% of respondents saying a victory for Donald Trump would lead to a further deterioration in U.S.-China relations.

This tension does not yet threaten the U.S. dollar's dominant role in FX reserves. Survey participants said their average share of dollar holdings was 55%, virtually unchanged from the previous year.

Five participants indicated that they introduced China's yuan as a new currency in their reserves, while two institutions recently dropped it.