MNI: China FX Policy Must Watch Sharply Weaker JPY On Trade

China’s central bank needs to enhance regional FX policy coordination because of the potential spillover effects of the sharp depreciation of the Japanese yen which may intensify volatility of Asian currencies and hurt exports, market analysts said.

The rapid drop of the yen, which reached a quarter century low above JPY135.50 to the dollar on Wednesday, was seen as pushed by the continued easy policy of the Bank of Japan, (See: MNI STATE OF PLAY: BOJ To Stay Easy Despite Weak Yen, Yields).

The weakness is increasing global economy uncertainties and elevated the CNY/JPY cross rate to levels that are seen as curbing China’s trade and investment outlook, said Xie Yaxuan, an analyst at China Merchants Securities.

The Chinese yuan rose to over 20 to JPY on Wednesday, the highest since the middle of April. According to Wind, the yen has dropped by 11% so far this year against the yuan, compared with a drop of 15% last year, and has dropped by 17% against the dollar.

China remains at a trade deficit with Japan, but both countries have deep supply and investment links.

Guan Tao, economist at BOC International, said the PBOC has increasingly struck a balance between domestic and external needs in a global high-inflation era. As well, China and Japan are two countries whose policy diverges from major western counterparts, and China needs to take the weaker yen and rising inflation in Japan into consideration.

The JPY has a 13.6% weighting in the dollar index. The sharp falls in JPY this year are already boosting the USD and undermine the performance of CNY against USD. According to Merchants Securities, the CNY’s real effective exchange rate against JPY rose 3.6% to 131.5 from 126.9 so far in June.

As a result, China’s exports are under currency pressure at a time when manufacturers need to be competitive in a still “hot “global demand environment, said Xie, calling for the PBOC to widen the yuan trading band to offset the spillover effects of a weaker yen and stronger dollar.

Tao Chuan, an analyst at Dongwu Securities, is concerned that JPY weakness may drag other Asian currencies into a depreciation cycle, noting most countries are export-oriented. The depreciation of their currencies is a highly “infective“ policy stance and may bring bigger pressure on regional economies.

Although the yuan has seen a rapid depreciation against the dollar since the end of March, falling to 6.80 from 6.30, the pace of decline was still slower than most of Asian currencies, said Tao, pointing out this puts the PBOC in a dilemma of managing domestic economic stability by further easing which may pressure the yuan at the risk of stoking imported inflation, (See: MNI: Euro Bonds Find Favour In China As Dollar Yields Rise).

Therefore, a slow and gradual depreciation of the yuan may be more appropriate, he said.

Analysts predict that JPY could fall further against USD without intervention by Japan. As well, the Fed could hike by 75 basis points on Wednesday putting pressure on the JPY.