FX Briefing

Highlights

• EUR-USD hits 4-week high, tension regarding Greece eases
• Swiss National Bank to continue intervening to prevent appreciation of Swiss franc
• China regards exchange rate peg as temporary measure

China: In No Hurry to Adjust Exchange Rates

Although there is still strong domestic resistance to the austerity measures in Greece, financial markets are starting to view the situation in a more relaxed light. This is probably partly thanks to prime minister George Papandreou's goodwill tour to the US, and partly as a result of the proposal to set up a European Monetary Fund (even though the ECB seems to be showing little enthusiasm for the idea). During the course of the week, EUR-USD firmed somewhat to almost 1.38.

On Thursday, the Swiss central bank published its quarterly monetary policy assessment. According to the SNB, the signs of an economic recovery are becoming increasingly evident, albeit in an uncertain environment. The bank confirmed its current expansionary monetary policy but, as in the previous quarter, indicated that over the entire forecast horizon (which also includes 2012) interest rates were set to rise. The SNB again confirmed its willingness to intervene by reiterating the standard phrase that it will act decisively to prevent an excessive appreciation of the franc. In the last few weeks, the SNB had intervened repeatedly when the franc had risen to about 1.46 against the euro.

Peking's exchange rate oracle

Last week, PBoC governor Zhou Xiaochuan caused a stir by stating that the yuan's peg to the dollar (since summer 2008) had been introduced as a special measure to combat the financial crisis. Some market participants interpreted this comment as a signal that there could soon be some movement in the USD-CNY exchange rate.

The PBoC oracle does not, however, give any indication of when that temporary exchange rate peg will be abolished. Minister of commerce, Chen Deming, for instance, said that it would take Chinese exports two to three years to get back to pre-crisis levels. The head of SAFE (China's State Administration of Foreign Exchange) stated that China wanted to keep the exchange rate “basically stable”, a phrase also used by China's premier Wen Jiabao in his speech before the National People's Congress.

This week saw the release of numerous Chinese economic data. The fact that in February inflation had accelerated to 2.7% from 1.5% the previous year caused a lot of concern. Inflation could well rise to over 3% in the next few months, but this should not be overdramatised, in our opinion. Food prices are the main driver of inflation; they have risen by over 6%. It should be borne in mind, however, that the exceptionally bad weather of the past few months and particularly strong demand in the run-up to Chinese New Year will have played a significant role.

The foreign trade figures indicate that export growth momentum is moderating. At $22bn, the trade balance surplus in the first two months of this year has dropped by almost half compared to the previous year. Exports in January and February combined have returned to the level of the beginning of 2008, imports, however, have risen much more sharply in 2010 than in any of the previous years.

Credit growth in China is still very robust, however. Admittedly the volume of new bank loans dropped from 1390 to 700bn yuan in February, but that is still a very large amount, particularly for a month influenced by New Year celebrations. Despite the sharp increase in 2009, bank loans grew by almost 30% year-on-year. At 23%, money supply growth (M2) was extremely high, even by Chinese standards. The benchmark for money supply growth is around 17%.

In our view, however, there is at present little danger of the Chinese economy overheating. The export sector is recovering but exports are not generating the momentum. Investment activity is particularly buoyant, especially as loans are easy to come by and households and companies have large amounts of liquidity at their disposal. In our view, this constellation suggests further monetary policy tightening by raising interest rates and deposit reserve ratios. From China's point of view, an appreciation of the yuan, which would dampen exports, is not urgent. Furthermore, it is uncertain whether an appreciation of the yuan would slow down capital inflows from abroad or boost them.

We expect the Chinese economy to at best allow very cautious exchange rate changes. But the yuan is likely to remain in the spotlight in the next few weeks. This week US president Barack Obama joined the debate by pressing China to move to a “more market-oriented” exchange rate. US policymakers will have a further opportunity to criticise China and make trade policy threats in mid-April in the semiannual report on “International Economic and Exchange Rate Policies”, in which the US Treasury Department decides whether a currency is being unfairly manipulated. But the US government will presumably wish to avoid an escalation of the conflict.

BHF-BANK
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