China’s yuan may hit a 17-year high in the coming week as stocks rise and bonds fall after the central bank raised interest rates for the third time in four months to curb inflation, if history is a guide.
The currency of the world’s fastest-growing economy closed at 6.5938 per dollar in Shanghai today, unchanged from its close on Feb. 1, the last day of trading before the weeklong Lunar New Year holiday. It reached 6.5808 on Jan. 21, the strongest level since China unified official and market exchange rates at the end of 1993. The one-year interest-rate swap jumped 22 basis points to 3.90 percent.
Emerging economies are weighing the need to curb inflation against the risk of attracting speculative capital from near- zero interest rates in the U.S. and Europe. China’s base rate is still below the nation’s inflation rate, giving savers an incentive to spend their money rather than keep it in the bank.
“They fear the risk of overheating,” said Thomas Rutz, head of emerging markets and currency in Zurich at Clariden Leu AG, which manages $1.3 billion in developing-market assets. “Tightening in the currency should go in line with the policy rate tightening. I still believe in the yuan going to 6 per dollar this year.”
The central bank’s quarter-percentage point increase in the one-year deposit rate to 3 percent still leaves China’s benchmark below Brazil’s 11.25 percent, India’s 6.5 percent and Russia’s 7.75 percent, according to data compiled by Bloomberg. China’s inflation may have climbed to as much as 6 percent in January after snowstorms damaged crops and as demand climbed before the holiday, according to Daiwa Capital Markets.
China’s currency has appreciated 3.5 percent since a two- year peg to its counterpart was relaxed in June, helping to reduce import costs. It climbed 0.6 percent in the week after the last interest-rate rise on Dec. 25 and 0.3 percent following the prior increase on Oct. 19. Some U.S. lawmakers have accused China of keeping its currency artificially weak to benefit exporters.
“The yuan will end up being stronger than what the market is discounting in a year’s time,” said Venkatraman Anantha- Nageswaran, the global chief investment officer in Singapore at Bank Julius Baer & Co., which oversees some $172 billion of assets. “The final outcome in one-year’s time will be between 6.2 and 6.4.”
China’s currency will appreciate 4.7 percent in the remainder of this year, according to the median forecast of 25 analysts surveyed by Bloomberg. India’s rupee is expected to gain 3.6 percent, while Brazil’s real and Russia’s ruble are forecast to fall 2.1 percent and 3.7 percent respectively, separate surveys show.
China’s government bonds fell this year, driving 10-year yields to their highest level since September 2008, as banks reined in demand for the securities after being ordered to set aside more funds as reserves. The rate rose 12 basis points to close at 4.03 percent on Feb. 1, according to data compiled by Bloomberg. It increased eight basis points, or 0.08 percentage points, after China last raised rates.
“As they raise interest rates more, it’s an admission that controlling money supply in China is not working to curb inflation,” said Kobsidthi Silpachai, head of capital markets research at Kasikornbank Pcl in Bangkok. “It also shows that they need to eventually make the yuan more flexible.”
Five-year credit-default swaps on China’s bonds rose one basis point yesterday to 74, according to CMA prices in New York. Credit-default swap indexes are benchmarks for protecting debt against default and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.
China’s stocks declined today, dragging the CSI 300 Index 1.2 percent lower to 3,040.95. In the week following October’s interest-rate increase, the gauge climbed 2.7 percent. The index retreated 1.1 percent in the week after the Dec. 25 revision.
The CSI 300 is still 15 percent below where it was at the beginning of last year, before China began tightening monetary policy. In addition to raising rates, the PBOC has raised the reserve-ratio requirement for major banks seven times since the beginning of 2010 and introduced stricter policies for lending for second- and third-home purchases.
The CSI 300 Index has fallen 14 percent since reaching a 10-month high on Nov. 8, dragging the average valuation of its companies down to 14 times estimated profit. That compares with about 19.5 times at the November high.
“This was pretty much in the price,” said Anantha- Nageswaran at Julius Baer. “China shares are not expensive at this stage.”
China’s policy makers also raised the one-year lending rate to 6.06 percent from 5.81 percent, effective today. The central bank moved on the last day of a weeklong holiday and before a report next week that may show consumer prices rose 5.3 percent in January, according to the median estimate in a Bloomberg News survey of economists. That would be the highest inflation rate since July 2008.
A drought that’s threatening grain production and a New Year surge in lending are adding to inflation risks after money supply jumped more than 50 percent in two years. Consumer prices rose 4.6 percent in December and 5.1 percent in November, the most in 28 months, while the economy expanded 9.8 percent in the fourth quarter.
Commodities fell on concern demand will decline in China, the world’s biggest buyer of energy, industrial metals and soybeans. Copper for three-month delivery on the London Metal Exchange fell as much as 0.7 percent to $9,990 a metric ton. Aluminum, zinc, lead, nickel and tin also declined.
China’s foreign-exchange reserves, the world’s biggest, climbed by a record $199 billion in the fourth quarter to $2.85 trillion, and banks extended 7.95 trillion yuan ($1.2 trillion) of new loans last year, exceeding the government’s targeted maximum of 7.5 trillion yuan.
China’s 0.75 percentage point of rate increases since the global financial crisis compares with India raising borrowing costs seven times for a total of 1.75 percentage points. China is among Asian countries that risk being caught in a “policy trap” by not raising interest rates fast enough to curb inflationary pressures, Stephen Roach, non-executive chairman of Morgan Stanley Asia Ltd., said in a note yesterday.
--David Yong, V. Ramakrishnan, Fion Li, Li Yanping, Kevin Hamlin, Marco Lui, Yumi Teso. Editors: Sandy Hendry, James Regan
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