MNI INTERVIEW: PBOC To Tolerate Yuan Strength Unless Excessive

The People's Bank of China is likely to continue to tolerate market-driven volatility of the yuan, though it could move against any sentiment-driven excessive strength in the currency if necessary, a senior policy advisor told MNI, pointing to tools such as the PBOC's countercyclical factor used to adjust daily fixing levels, as well as its foreign exchange reserves or adjustments to capital controls.

The yuan closed at a three-year high 6.3758 to the dollar at 16:40pm in Beijing time on Thursday, driven partly by surging inflows into Chinese equities, after breaking the 6.4 level on Tuesday. While the yuan could rally further, maybe even briefly breaching 6.3, the 1994 high of 6.1 is out of reach and the currency could weaken to 6.7 by the fourth quarter, or earlier, if U.S. inflation pushes Treasury yields higher, Zhang Ming, deputy director of the Institute of Finance and Banking under the Chinese Academy of Social Sciences, said in an interview.

While a major driver of a yuan reversal would be expectations for tighter U.S. monetary policy, support for the currency from flows into Chinese equity markets is also unsustainable, said Zhang. Speculation that the PBOC could look favourably upon continued yuan appreciation as a means of limiting spillovers into domestic inflation from more expensive commodities is also misguided, he said, adding that materials price rises are already losing steam.

COUNTERCYCLICAL FACTOR

Though the yuan's managed float generally keeps the central bank on the sidelines of the foreign exchange market, it has tools to make moderate adjustments if necessary, including the "countercyclical factor" it can apply to its daily price fixing, Zhang said.

Chinese equity markets saw a net inflow of CNY21.7 billion on Tuesday, the most since the launch of Shanghai-Hongkong and Shenzhen-Hongkong Stock Connects, driving a 3.16% daily jump in the CSI300 index. Foreign investors are bargain-hunting after leading companies' A-shares plunged by over 30% following the Chinese New Year, but such flows are unlikely to be sustained, Zhang said.

Meanwhile U.S. GDP growth could approach or even exceed China's in the fourth quarter, and rising U.S. inflation will narrow the yield spread between Treasuries and Chinese government bonds, said Zhang, who saw the dollar index falling no further than 88 or 87 from current levels around 90 before a recovery.

The yuan could also eventually come under pressure as the end of the pandemic reduces demand for some Chinese exports and services imports recover, he said. But yuan-denominated assets, particularly bonds, are increasingly attractive at a time when developed market yields are often negative, he said, noting that this should help China's currency consolidate its international status.