Currencies: China starts to wriggle in dollar straitjacket

The Chinese yuan posted its biggest five-day drop since August last week – shedding 0.83% – after the central bank lowered the daily “reference rate” by a similar amount. The reference rate is the point around which the yuan-dollar exchange rate is allowed to fluctuate; the authorities haven’t reduced it by this much since the summer’s surprise devaluation.

Meanwhile, late last week, the government announced that it would begin publishing a new exchange rate index, which tracks the yuan against 13 trading partners’ currencies.

Given the likely upward pressure on the dollar that would arise when the US Federal Reserve starts hiking interest rates, China’s central bank appears to have moved pre-emptively to prevent the yuan being dragged upwards behind it. In the pasttwo years the link to the strengthening dollar has bolstered the yuan significantly in trade-weighted terms, says Capital Economics.

The apparent shift to managing the currency through a basket suggests that the central bank “sees the link to the dollar as a straitjacket from which it wants to escape”. Not only is the yuan being dragged up, but whenever the authorities devalue the yuan, markets get jittery because they think it is a sign of weakness in the economy.

By shifting the focus away from the yuan-dollar rate, the bank hopes to “guide the yuan lower without sparking market unease”, says Nyshka Chandran on In any case, reckons Capital Economics, worries over China should soon subside: the latest data suggest it “is turning a corner”.

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