China grapples with yuan messages amid inflationary pressures

(May 25): China’s central bank has sought to clarify that it will not let the yuan strengthen too much, too quickly, as mixed signals from officials highlight the challenges posed by a currency exchange close to a three-year peak.

The exchange rate will remain “fundamentally stable,” the vice-governor of the People’s Bank of China said in a statement on Sunday. Earlier, another central bank official wrote that the yuan is expected to appreciate to offset the higher costs of raw material imports. The essay, published in a state-backed magazine on Friday, has since been deleted. Separately, another official said that China must give up its control over the exchange rate to achieve greater global use of the yuan.

With soaring prices at the factory gate, a stronger yuan helps lower the cost of imports, such as commodities – a key component of inflation. Still, any sign that Beijing is encouraging the currency’s gains may prompt traders to bet on further appreciation, triggering capital inflows that could inflate asset bubbles.

On Tuesday, the PBOC set its daily benchmark rate – which limits the onshore yuan’s movements by 2% on each side – lower than analysts and traders had expected. He has set the fixing lower than expected on all but three days this month, suggesting that his tolerance for a strong currency is fading.

“The PBOC has a higher tolerance for the strength of the yuan, but that doesn’t mean it wants to see large capital inflows or outflows, a directional trend or high volatility,” said Becky Liu, head of the macroeconomic strategy for China at Standard Chartered Plc. . in Hong Kong. “Therefore, when he thinks that the yuan supply and demand are out of balance, he will use fixation to manage expectations.”

The yuan gained 2.2% this quarter, making it one of the best performers in Asia. The rally was fueled by dollar weakness, which is near a three-year low. Capital inflows helped accelerate gains as foreign funds bought yuan bonds that will be included in global indices and offer more attractive returns.

China has long resisted its one-way currency appreciation, which became a major concern after foreign investors increased their holdings of onshore stocks and bonds by nearly 70% from the year to March.

An appreciating local currency also makes Chinese exports less competitive. “The main risk of such a strong yuan is that it hurts exports, and as such, it hurts exporters and therefore producers in the same way as high commodity prices,” said Iris Pang, Chief Economist for Greater China at ING Bank NV.

The PBOC does more than just send verbal signals and fix weak fixings. The authorities also increased the quota of onshore investors to buy assets abroad in January and March, reflecting Beijing’s desire to see more capital outflows. The onshore yuan gained as much as 0.3% to 6.4030 per dollar, the highest level since June 2018 on Tuesday.

“The yuan will still have room for improvement in the near term as the dollar remains weak,” said Tommy Ong, general manager of treasury and markets at DBS Hong Kong Ltd. “But the BPC will probably manage expectations when the rally gets too fast.”

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