CNY: Where to now?

It has become overwhelmingly clear that the strengthening in the CNY against the dollar has once again paused. We’ve seen similar stretches of sideways movement in early 2012 and around the turn of the year. The big question now is how long will this period last, and will we see an actual weakening, like in mid-2012?

GDP growth in China slowed to 7.5% y/y in Q2, and although we expect a stabilisation, growth is fragile. Export growth has slowed again and the manufacturing PMI only adds to the gloomy picture. Against this backdrop it’s not at all surprising that we’ve heard of some mini stimulus (e.g. tax cuts for small businesses, opening up the railway construction sector, and reducing costs for exporters) and indications that the juan exchange rate will be kept stable (to help exporters, presumably).

The mini stimulus measures announced seem of fairly small calibre. We have already earlier opined that a larger-than-life investment stimulus package is not on the cards, while gentler measures to fine-tune fiscal policy are likely to surface as we go along.

Although the slowdown in growth has partly been in line with the grand plan to rebalance the economy from investments towards private consumption, there seems to be some fears within the leading pack that the slowdown could take a step too far. This is something to worry about, because too weak growth in the Chinese economy means (among other things) a weaker labour market, which in turn could mean social unrest. Recent comments from the premier and vice premier indicate that the tolerance level for GDP growth remains at 7.0-7.5%. To be on the safe side, some modest stimulus is needed to tide the economy over until the US and the euro area get a proper grip.

Regarding the CNY, Chinese authorities have earlier talked about the importance of two-way fluctuation in the exchange rate. This was followed by the short-lived but evident weakening early last summer. This week the State Council pledged to promote exchange rate stability (no mention of two-way flexibility), and although a weakening in CNY would be welcome for the struggling export sector, current comments indicate at most a modest depreciation in the CNY. Our 3M FX forecast of USD/CNY at 6.15 (currently 6.1345) reflects this.

But neither should one expect a continuation of the strengthening trend in the near term. The fragile economy does not warrant a stronger currency. This can wait, until the economy picks up, which we’ve pencilled in for Q4.

So don’t expect large moves in the CNY over the next few months. “Sideways” is here to stay for a while, at least. But be prepared for a weakening. If the strengthening pressure is not too heavy, a widening of the +/-1% trading band could be in store later this year. This would increase volatility and risk, and hence could provide reason for a weakening in the immediate aftermath. If the economy underperforms and export demand does not pick up, the only logical way for the CNY is weaker.









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