According to Sky News, the move by the People’s Bank of China serves to highlight the increasing level of concern awarded to the world’s second largest economy.
As previously reported, Chinese exports in July came in 8.3 per cent lower than the prior year after fears that the strength of the yuan was rendering Chinese exports uncompetitive.
A strong currency makes a country’s exports more expensive, which in turn reduces export volume therefore eroding any trade surplus.
China determines a midpoint level for the value of the yuan. The currency is then allowed to move 2 per cent above or below this midpoint in daily trading, this is known as the daily fixing.
However, Chinese officials sometimes disregard the daily moves and on occasions set the daily fixing such that the yuan is stronger against the dollar a day after the market has indicated it should be weaker.
Today the dollar/yuan fixing was at 6.33 – 1.6 per cent weaker than Tuesday’s fix, which in turn was 1.9 per cent weaker than Monday’s.
Following the announcement of this morning’s fix, the yuan weakened by 1.4 per cent, on the onshore markets, to 6.42.
On the offshore markets, where trading isn’t restricted by the daily 2 per cent band, the Chinese currency weakened 1.8 per cent to 6.5 – its weakest level in four-and-a-half years.
In addition, to its attempts to restore export volumes it is also rumoured that the Chinese are hoping to achieve reserve currency status.
For the yuan to be included in the International Monetary Fund’s (IMF) basket of reserve currencies, known as the the Special Drawing Rights or SDR, reforms which make the setting of the yuan’s value more market-determined and transparent are widely believed to be needed.
The IMF welcomed the decision saying: ““The new mechanism for determining the central parity of the Renminbi [yuan] announced by the PBC [People’s Bank of China] appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate.”
The People’s Bank of China insists there is no ground for sustained yuan depreciation, however a second consecutive daily devaluation would suggest otherwise.
Tuesday’s devaluation saw sharp falls in the shares of European and US exporters to China with Apple, Burberry, BMW and Louis Vuitton owner LVMH all losing ground.
China’s aspiring middle classes have been key customers to these luxury goods brands, and the devaluation will make them more expensive to Chinese consumers, thereby impacting the companies profitability.
In order to weaken the currency, the People’s Bank of China will have to buy US treasuries to weaken their domestic currency.
This will lead to a stronger dollar which could delay the Fed’s decision on when to raise interest rates. Despite, Tuesday’s move JP Morgan, the US investment bank, reiterated its expectation for a September US rate rise.
Asian equity markets were in negative territory following the announcement with the Hang Seng in Hong Kong trading 2 per cent lower.
