The ending of the renminbi peg with the US dollar; China tries to stall rise in currency

The ending of the renminbi peg with the US dollar; China tries to stall rise in currency

Following Saturday's surprise announcement by the People's Bank of China (PBoC) of an ending of the renminbi peg with the US dollar that had been in effect since July 2008, and the return the managed float system, which resulted in a rise in the value of the Chinese currency by 17.5% since mid-2005, China on Tuesday left the renminbi drop slightly in value against the dollar in a move that was seen as deterring speculators benefiting from a stronger currency.

The PBoC had initially set the reference point for the day's trading 0.43% above Monday's level, to the highest level in five years, which appeared to be a signal it was comfortable to see a slight appreciation in the currency. However, while the renminbi initially rose against the dollar, by the end of trading Tuesday it had fallen 0.23% to CNY6.8136 compared with the peg rate of 6.828. Traders are reported to have said state-owned banks had been in the market buying dollars, which they saw as a sign the authorities were trying to control tightly the value of the renminbi and limit expectations of future gains. On Monday the currency rose 0.42% against the dollar.





In the markets, the optimism that greeted China's decision, in advance of the G-20 summit in Toronto this weekend, was replaced Tuesday with continuing concerns about the Eurozone banking sector and the US housing market.

Morgan Stanley economist, Qing Wang, based in Hong Kong, summarised the impact of China's move.

1) A renminbi exit from the USD peg would lower the risk premium of the equity market stemming from fear of a Sino-US trade war.

2) It helps contain ‘imported' inflation pressures and therefore reduces the probability of an aggressive monetary tightening in China through stringent credit controls and/or consecutive interest rate hikes.

3) A modest initial revaluation to be followed by gradual appreciation would fuel expectations of further appreciation over time.

Impact on our economic and policy calls:

MS said it maintains its forecasts for the USD/CNY spot rate to reach 6.60 by end-2010 and 6.20 by end-2011.

It changed its interest call from "no more than one rate hike in 2H10" to "no rate hikes through 2010".

It attaches a high probability that the target of new bank lending of Rmb7.5trn for 2010 could be revised upward by 4Q10.

In view of this desirable policy change, MS maintains its call for a Goldilocks scenario (not too hot or too cold) in 2010, featuring 11% GDP growth and 3.2% average CPI inflation, while noting that the balance of risks on both fronts is tilted slightly to the downside.