China to allow Yuan more flexibility to float
China's yuan surged on Monday by the most of any day since its landmark revaluation in 2005, sending a clear signal ahead of this weekend's G20 summit that Beijing is keeping to its word and allowing more currency flexibility. The central bank has maintained a de facto peg since the middle of 2008, a controversial policy aimed at steadying the world's fastest-growing major economy during the global economic downturn.
But the People's Bank of China (PBOC) stepped aside on Monday to back up its surprise weekend announcement that it would allow more flexibility for the yuan, buying some time against critics who argue the currency is undervalued and gives China an unfair advantage in trade.
After setting the mid-point for the day's trading range, the central bank let the currency rise 0.42% to 6.7976 per dollar, both the biggest daily gain and the highest close since China revalued the currency and introduced a managed float regime in 2005. At one point, the yuan was up as much as 0.47% from the day's mid-point, just shy of the currency's 0.5% limit, which had rarely been tested in practice in the past.
Traders said the absence of intervention from the central bank suggested it wanted the market to drive intraday trade and so underline its weekend pledge. But it also showed it had ultimate control by setting the reference rate, around which the yuan can trade, at the same level as Friday's fixing.
Traders said it was unlikely the yuan would repeat gains on the same scale in coming days, with Tuesday's mid-point setting serving as an important barometer of how much more appreciation the central bank is willing to stomach.
"It is still too early to say what the PBOC is going to do in the coming days but we expect the trend to be gradually lower rather than volatile," said Callum Henderson, global head of FX strategy at Standard Chartered Bank in Singapore. "Tomorrow's fixing is awfully key in terms of the sentiment of the market. One can pontificate on what is going to happen based on one day, but frankly it is a guessing game on what is going to happen. We will have to see the fixing tomorrow and that should set the tone for the next couple of days."
China's economic strength gave policymakers confidence to end the peg, but they remain worried demand for China's export is not on a solid footing given risks like Europe's debt woes. The central bank ruled out a one-off revaluation of the currency and suggested the yuan's value was close to fair value. Still, analysts said China needs to show the G20, whose leaders meet June 26-27 in Canada to discuss issues including global trade imbalances, that it is serious in its commitment to make the yuan more flexible.
Indeed, the United States called for "vigorous implementation" of the policy, and some of the strongest critics of China's policy in the US Congress are unlikely to be easily impressed. Monday's gain in the yuan, small by comparison with freely floating currencies, is likely to be enough to ease tensions at the upcoming G20 summit, Ben Simpfendorfer, strategist with Royal Bank of Scotland, said in a note to clients. But tensions are likely to return following the summit, as the scope of appreciation disappoints critics who complain Beijing has used the peg to gain an unfair trade advantage.
"If so, fault lines at the heart of the U.S.-China relationship will be largely to blame," Simpfendorfer said. "The former is a developed Western country run by politicians subject to the short-term demands of an electoral cycle. The latter is a developing Eastern country run by state planners subject to the medium-term demands of living standards and social stability."
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