International | May 22 2007
By Chris Shaw
Given the Chinese currency has never tested its 3% trading band against the US dollar the decision by authorities to widen this to a 5% range seems unlikely to make any real difference to the rate of appreciation of the yuan against the greenback.
ANZ Bank’s head of international economics Amy Auster is one to take this view, pointing out the move should have little impact as the mid-point of the currency’s trading range is fixed every day.
Auster suggests one possible benefit of the move is it provides a better chance for authorities to teach currency market participants about hedging and the pricing of currency risk, but she has not adjusted her forecast for the yuan of 7.45 against the US dollar by the end of the year as a result of the change.
Danske Bank senior analyst Flemming Nielsen is a little more optimistic of the potential for the change to speed up the pace of currency appreciation though, giving two reasons why this may occur.
The first is political, as China and the US are entering trade negotiations this week and protectionism is sure to be on the agenda. Nielsen sees the move to widen the trading band as partly a political gesture, as it gives China an additional bargaining chip in the negotiations.
The second reason it may promote a faster pace of appreciation. It is his view it is really in China’s interests for this to happen. With Chinese and US business cycles having de-coupled Nielsen argues the Chinese need greater flexibility and independence in terms of their policy settings and one way to achieve this is by letting the currency move higher.
While interest rates have been the preferred means of attempting to reduce liquidity in the economy this has met with limited success to date, Nielsen pointing to the potential for higher interest rates to eventually damage the economy as they will be inefficient in limiting capital inflows if the currency continues to be undervalued.
While ANZ’s forecast of 7.45 for the yuan against the US dollar by year’s end is in line with market consensus, Nielsen’s view is this may prove conservative and the latest move with respect to the width of the trading band is likely to help the currency strengthen by more than the 2.8% implied by the consensus forecast.
