Currencies | Jun 21 2010
By Chris Shaw
In something of a surprise announcement over the weekend, the People's Bank of China (PBoC) has flagged an end to the renminbi's peg against the US dollar. The peg has been in place for the past 23 months.
The PBoC statement said the currency would gradually become more flexible, which Commonwealth Bank suggests implies a return to an annual rate of appreciation of about 5-6% annually. Exchange rate floating bands will remain in place.
The bank's chief currency strategist Richard Grace suggests the timing of the PBoC move comes a little earlier than expected, which can in part be explained by both the Chinese and global economies having begun to recover post the global recession.
Grace notes the move also gives Chinese policymakers some additional flexibility to deal with rising inflationary pressures. Chinese CPI for the year to May 2010 was 3.1%. As well, Grace suggests the move leaves China better placed to cope with any rise in the US Fed funds rate, something he expects will happen later this year.
National Australia Bank head of currency strategy John Kyriakopoulos notes the change in Chinese policy comes a week before the G20 leaders summit in Toronto. The move should therefore go some way to cooling trade tensions with the US.
This should be a positive for investor sentiment in Kyriakopoulos's view, as evidenced by S&P500 futures jumping more than 1% on news of the announcement. China expects the move will help direct investment to domestic sectors of its economy, something that should reduce an over-reliance on the export sector.
Kyriakopoulos suggests this should help reduce global imbalances but won't be enough on its own, as for this process to be fully effective there needs be higher savings rates in the US and higher consumption in the Chinese economy.
Grace notes as a percentage of GDP China's current account surplus has been narrowing over the last eighteen months. This means short-term pressure on China's exchange rate might not be as great as if the surplus had increased over that period.
The recent depreciation in the euro has seen China's Trade Weighted Index increase in both real and nominal terms, which Grace also suggests will lessen the short-term upward pressures on the Chinese currency.
Regional currencies of nations exporting to China or that compete with Chinese exports should benefit from the move, though Kyriakopoulos doesn't expect significant rises in coming months if China allows only modest appreciation of its currency against the US dollar this year.
The Chinese announcement should be a positive for the Australian dollar according to Grace, as the move gives China additional tools to control inflation. This implies the duration of China's economic expansion will be extended.
As well, Grace notes a gradual appreciation of the renminbi makes China's imports of Australian exports less expensive, given around 80% of these exports to China are used in the domestic Chinese economy.
The other trend Grace expects is as China's currency appreciates other Asian central banks are likely to allow their currencies to appreciate as well. This reflects the fact gains in the Chinese currency would mean other Asian currencies could also appreciate without losing their competitiveness.
The Australian dollar is strongly correlated with movements in Asian exchange rates, Grace noting around 70% of Australian merchandise exports go directly into the Asian region.
Investor risk appetite before the PBoC announcement was improving, as global stock markets had recorded two consecutive weeks of gains as fears of a global recession eased. National Australia Bank's risk-appetite index has similarly improved, rising to 53% as at the end of last week from 38% two weeks ago. Given 50% is the long-term average for this index, Kyriakopoulos notes investor risk-aversion has clearly unwound.
From a technical viewpoint, Kyriakopoulos suggests a close above USD0.8725 is a positive for the Australian dollar, while the next resistance level is at USD0.8880. The bank's short-term model suggests fair value for the Aussie dollar against the greenback is USD0.8550 at present.
Grace is more positive, suggesting the combination of a relaxation in China's exchange rate policy and an expected further recovery in both equity markets and base metal prices will see further gains in the Australian dollar. He expects a test of USD0.9000 in coming weeks.
