The yuan will, from today, be able to trade as much as 2 percent on either side of a daily central bank reference rate, from 1 percent previously, the People’s Bank of China said in a statement on its website on March 15. The band was last widened in April 2012 from 0.5 percent, and before that from 0.3 percent in May 2007.
The move underscores pledges from China’s leaders to make the exchange rate more market based and promote freer movement of capital in and out of the country for investment purposes. The central bank said it will continue to increase the yuan’s two-way flexibility after last month highlighting an “orderly” broadening of the currency’s trading band among its 2014 policy goals.
The band widening “strengthens the PBOC’s signal that the one-way bet on the yuan’s gain is over and we should expect much more yuan-dollar volatility going forward,” Lu Ting, head of Greater China economics at Bank of America Corp. in Hong Kong, said in an e-mail. “Further band widening is of little meaning. A much more important and meaningful reform is to change the rule on setting the daily fixing.”
The central bank needs to shift to a new market-based system, Lu said. As an intermediate step in improving the fixing, it could peg the yuan to a basket of currencies weighted by the importance of its trading partners, Lu said.
While the PBOC will “basically exit” normal foreign-exchange intervention to allow markets a greater role, it will “conduct the necessary adjustment and management” in cases of abnormally large fluctuations, the central bank said in a separate statement on March 15.
U.S. Treasury Secretary Jacob J. Lew told Chinese Vice Premier Wang Yang in a phone conversation March 15 that the world’s second-largest economy needs to move toward a market-determined exchange rate. Lew also praised China’s announcement to widen the daily trading band, the Treasury said in an e-mailed statement yesterday.
The currency has slid 1.8 percent from a 20-year high of 6.0406 per dollar reached on Jan. 14, after strengthening 2.9 percent in 2013. The yuan fell as much as 0.86 percent on Feb. 28, the biggest intraday loss in China Foreign Exchange Trade System prices going back to 2007. The drop was also the largest since China unified official and market exchange rates at the start of 1994. It closed at 6.1502 on March 14. The onshore spot rate will start trading at 9:30 a.m. today in Shanghai.
Recent weakness was driven by the central bank in order to curb one-way appreciation bets before broadening the trading limit, HSBC Holdings Plc strategists led by Paul Mackel wrote in a March 15 note.
One-month implied volatility in the onshore yuan, a measure of expected moves in the exchange rate used to price options, touched an 18-month high of 2.49 percent on March 14. Non-deliverable forwards due in 12 months completed the biggest weekly drop since November 2011.
The “knee-jerk” market reaction is likely to be higher yuan volatility, while long-dated yuan forwards will weaken further, Albert Leung, Hong Kong-based local market strategist for Asia at Bank of America, said in an e-mail.
The PBOC announcement followed data signaling an economic slowdown that may make Premier Li Keqiang’s 2014 expansion target of about 7.5 percent harder to reach. Industrial output had the weakest January-February growth since 2009 and fixed-asset investment increased at the slowest pace for the two-month period in 13 years, reports last week showed.
At least seven institutions including Bank of America, Nomura Holdings Inc., JPMorgan Chase & Co., UBS AG, Mizuho Securities Asia Ltd., Barclays Plc and Daiwa Capital Markets lowered their forecasts for gross domestic product growth after the data.
GDP rose 7.7 percent in 2013, the same pace as in 2012, which was the weakest increase since 1999.
Yuan appreciation and capital inflows are unlikely amid the weak economic data, JPMorgan economists led by Zhu Haibin wrote in a research note. “Yuan depreciation could support exports, and capital outflow will drain domestic liquidity and open the window for reserve-requirement ratio cuts by the PBOC,” they said. Zhu cut his 2014 growth estimate to 7.2 percent from 7.4 percent last week.
The reserve ratio, the amount of cash lenders must set aside at the central bank, has been kept at 20 percent for the largest banks since the last reduction in May 2012.
“With the band widening and, more importantly, recent spate of weak China data, we think the bias is for near-term weakness of the yuan and potentially higher volatility,” Irene Cheung, Singapore-based foreign-exchange strategist at Australia & New Zealand Banking Group Ltd., said in an e-mail.
The majority of 29 analysts surveyed by Bloomberg News last month had said they expected the PBOC to double the yuan’s daily limit by the end of June, after the central bank listed it among its goals for 2014 in a Feb. 19 statement.
PBOC Governor Zhou Xiaochuan highlighted an “orderly” widening of the band in a guidebook in November that explained policy changes outlined at a Communist Party summit earlier that month. The meeting pledged to give markets a “decisive” role in the pricing of resources, with acceleration of yuan convertibility and liberalization of interest rates among the proposals.
“Widening the trading band will help companies and residents recognize the exchange rate as a key price factor in the allocation of resources,” the PBOC said, adding that the increase is “within the bearable range” for market players.
“With the progress of reform toward a market-oriented exchange-rate mechanism, the yuan will in the future be like other major international currencies with fully-flexible two-way movement as the norm,” it said.
To contact the reporter on this story: Fion Li in Hong Kong at firstname.lastname@example.org