China introduces currency index as yuan hits four-year dollar low

The Chinese yuan hit its lowest level against the dollar since July 2011 on Friday amid signs that the Chinese authorities are keen both to weaken the currency to improve competitiveness and to divert attention away from the dollar/yuan exchange rate towards a broader currency basket.

In a statement on the People’s Bank of China website, the central bank announced on Friday that it is introducing an exchange rate index which, it hopes “will help bring about a shift in how the public and the market observe RMB exchange rate movements”. The RMB, or renminbi, is an alternative name for the yuan.

“The People’s Bank has just announced what could end up being a significant shift in currency policy,” writes Mark Williams, chief China economist at Capital Economics.

“The fixation on the dollar spot rate has put the PBOC in a difficult position in the past couple of years. Because of the link to the strengthening dollar, the renminbi has appreciated significantly in trade-weighted terms. Yet any sustained weakness in the renminbi relative to the dollar tends to be interpreted as ‘devaluation’ and trigger market concerns. The timing of this announcement is significant, on the cusp of tightening by the Fed, which could feed further dollar strength,” he adds.

Late in the European day on Friday, the dollar was up another 0.3% at 6.4538 yuan, its highest level for more than four years, as analysts speculated that an increase by the Federal Reserve in US interest rates next Wednesday is a near certainty.

“The world will be watching the renminbi more closely than usual over the days ahead. It has weakened against the dollar in recent trading. If the renminbi does continue to weaken, the key point is that this should not automatically be interpreted as devaluation or even depreciation if it is happening against a backdrop of dollar strength. The renminbi has lost ground relative to the dollar this year, but the PBOC says that it has appreciated 2.9% relative to the new basket,” writes Williams.

An important consideration in the weakness of the yuan against the dollar appears to be the anticipated Fed rate hike next week, writes Marc Chandler and his global currency strategy team at Brown Brothers Harriman.

“The PBOC still is in an easing mode. As the monetary cycles diverge, the tight relationship between the yuan and the dollar poses a challenge. However, it is important to keep in mind the magnitude of the moves we are talking about. The yuan has fallen about 0.8% this week. Year-to-date, it has depreciated by about 3.8%, making it the fourth best Asian currency performer this year, behind the Hong Kong dollar (pegged), Japanese yen (-1.6%) and Taiwanese dollar (-3.6%),” they add.

Analysts say further depreciation of the yuan remains highly likely as the Chinese authorities seek to boost economic growth and avoid capital outflows by making Chinese exports more competitive. This weekend, more Chinese data on fixed-asset investment, industrial production and retail sales should help make it clearer how successful they are being.

“Fixed investment growth probably picked up further in November in response to policy easing; similarly industrial output should also have recovered. And a tight labour market suggests retail sales growth is likely to have remained healthy too,” writes Capital Economics.

This post was first published by news.markets: http://news.markets/forex/china-introduces-currency-index-yuan-hits-four-year-dollar-low-6656/