MNI INTERVIEW: Yuan Strength Seen Ebbing, Mid-Point At 6.5

The People's Bank of China may welcome a move to tighter monetary policy by the U.S. Federal Reserve, as it would ease upwards pressure on the yuan and capital inflows, a former official told MNI, adding that the Chinese currency would likely trade in a wide band around a mid-point of 6.5 to the greenback for the rest of the year.

The onshore yuan gained as much as 0.23% Wednesday and closed at 6.3930 per dollar, its strongest since June 2018, also rallying 0.4% in the offshore market. This took its gains against the greenback to 1.2% so far in May, adding to April's 1.3% appreciation. But the U.S. currency may be about to strengthen, possibly taking the dollar index to 93 and pushing the yuan lower around a mid-point of 6.5, said Guan Tao, a former director general of balance of payments at the State Administration of Foreign Exchange. The dollar index, currently just under 90, could rise if the U.S. economic recovery outpaces that of the eurozone, he said in an interview.

The yuan is already in a quasi-free float, with its trajectory increasingly linked to the dollar's performance, said Guan, now chief global economist at BOC International (China) Co Ltd. He spoke after several high-ranking regulators stressed they would keep the exchange rate "basically stable at a reasonable and balanced level", following speculation the PBOC could tolerate a stronger currency to boost its global status and counter rising domestic inflation. Earlier this year, advisors and traders told MNI that the yuan would be capped by the 1994 high of 6.1.

FED TIGHTENING

Having withdrawn from regular foreign exchange intervention, the PBOC's forex positions and China's foreign reserves have seen little change, Guan noted. But more should be done to further free the exchange rate regime in line with plans to open up China's financial services and promote yuan internationalisation, he said.

As U.S. inflation is driven higher by strong consumer demand, the Fed is likely to tighten policy earlier and more aggressively than the PBOC, according to Guan. Chinese consumer demand remains soft, and imports have only limited weight in the consumer prices basket, he added, predicting that inflation was unlikely to spike in the medium and long term.

While Fed tapering could have a devastating impact on emerging markets with significant needs for foreign funding, for China a stronger dollar and a narrower yield spread between the 10-year CGBs and U.S. Treasuries would have the benign effect of taming capital inflows into the domestic market and the yuan, Guan said.

China's uneven economic recovery requires continued policy support from the PBOC, he said, adding that the top priority for policy should be maintaining stability. China should make good use of the window of opportunity afforded by its current robust exports by laying the groundwork for boosting domestic demand, he said.

Employment data shows the economy, far from overheated, is cooling, he said. New jobs in urban areas totaled 2.97 million in the first quarter, lower than the 3.3 million in the same period in 2019 and 2018, with the number of migrant workers falling by 2.46 million.

Not only is the recovery unbalanced, with strength concentrated in exports, but the pandemic situation remains uncertain, Guan said, calling for continued support for investment and consumption if the country is to grow by 6% in 2022.