Rise of the RMB

A pivotal moment

What do rate cuts signal for the renminbi?

RMB-w

How much of an increase in interest rates should we expect this year? In the United States the Federal Reserve is coming under major pressure to raise rates because of inflation, which surged to 7% in December, the highest level in 40 years. The consensus view is that rates will begin to rise again in March, with three increases over the remainder of the year. JPMorgan chief executive Jamie Dimon reckons the Fed might even need to raise the benchmark rate seven times, although he hasn’t specified how soon that might happen.

The People’s Bank of China (PBoC) has just taken the opposite track, however, announcing a reduction of the one-year loan prime rate by 10 basis points to 3.7% on Thursday. Also this week, the central bank cut the five-year rate – used for pricing mortgages – for the first time since April 2020.

The tale of the two monetary policies is, in part, a story of two different responses to the Covid crisis. The yuan has appreciated by about 8.5% against the US dollar over the last two years, helped by a surge in China’s exports to Covid-constrained markets around the world, a trend that has fuelled record trade surpluses for the Chinese (see WiC563). And while Washington has gone full-throttle on monetary stimulus to counter the virus, Beijing’s approach has been “parsimonious”, reckons Nial Gooding, a fund manager in Hong Kong, in a commentary piece for his China Dream newsletter this week that highlighted the yuan’s appeal.

“One government’s policy is deflating the monetary value of assets denominated in its currency, the other’s is not. These different inflationary paths will have encouraged investors to accumulate renminbi-denominated assets, for which they’ll have needed to purchase renminbi,” he adds.

Gooding’s view is that further appreciation of the yuan would benefit the Chinese economy by encouraging investment in domestic businesses and reducing some of the impact of imported inflation.

But diverging paths in monetary policy could also start to bring the yuan down again against the dollar, especially in a context in which the Chinese economy showed signs of stumbling into the final weeks of 2021.

Data this week from the National Bureau of Statistics signalled the weakest GDP performance for 18 months in the quarter to December, with growth slowing to 4% (from 9% over the first nine months of 2021). One factor in the deceleration is the extended slowdown in the property sector. But Beijing’s ‘zero tolerance’ approach to Covid is also having a deadening effect by restricting the movement of tens of millions of urban residents (see WiC569).

As of the middle of this week at least nine cities were reporting rises in local transmissions, including the capital Beijing. Infection numbers are still tiny compared to many nations but commentators are forecasting a rougher ride for the economy because of the way the authorities are responding.

Eighteen months ago the Chinese were widely thought to be ahead of the rest of the world in finding their way past the worst of the pandemic. But Omicron’s spread seems to be reversing that assessment, in part because of the way that the Chinese are choosing to shelter from the latest waves of infection.

In the meantime, the government has decided that a reduction in rates is required to keep the economy moving forward and President Xi Jinping is also asking other nations not to put up interest rates themselves until they have recovered more robustly from the pandemic.

“If major economies slam on the brakes or make major U-turns in their monetary policies there will be serious negative spillovers,” he warned in a virtual speech to the World Economic Forum this week, claiming that developing nations would “bear the brunt” of the damage.

Of course, the Chinese won’t want to see a surge in interest rates in their key export markets, which might chill demand for their goods at a time when their domestic economy is slowing. But policymakers in North America and Europe may not take the same view, deciding the time has come to fight inflation in their own economies, whatever the consequences elsewhere.


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