By Chris Towner, director of FX advisory services

Chris Towner, director of FX advisory services at currency specialist HiFX, comments on China’s move to widen its trading band.

“As the Chinese economy has grown, there has been growing pressure on them to liberalise their currency so that it flows freely within the international foreign exchange markets, which amount to a daily volume of approximately 4 trillion US dollars," he said.

“Over the past few years the Chinese have tweaked their approach of managing their exchange rate to the US dollar from a peg to a managed float, which has ‘gradually’ allowed the renmimbi to strengthen against the US dollar. Since relinquishing the peg in 2005 which was at 8.28 renmimbi to the US dollar, we have seen the renmimbi strengthen by approximately 24% to currently trade just above the 6.30 level.

“The latest step (within a series of steps) has been to allow the renmimbi to trade by up to 1% against the US dollar per day, which allows potential movements for example of between 6.2370 to 6.3630, if USD/CNY were to be trading at 6.30. This has increased the potential for USD/CNY to be more volatile and the timing of this move is clever as it comes at a time of low levels of implied volatility in the FX markets. For example recently GBP/USD and GBP/EUR have also been trading within contained daily ranges of roughly 1%. Therefore what the Chinese have done here is to introduce a degree of normalisation in trading of their own currency while still having ultimate control as to where it trades and not fully exposing it to the speculators within a low volatility environment.

“Given the robust growth levels of China (8.1% at the latest reading) it is often presumed in the FX markets that if the Chinese renmimbi were to be allowed to float freely then we would see a strengthening in this currency. However we also note clever timing here as the Chinese authorities have recently downgraded their forecasted growth levels to 7.5% from 8%, thus allowing some doubt as to whether this currency would strengthen and indeed in reaction to the news, we have actually seen the renmimbi weaken.

“Therefore at their own chosen pace we are seeing the Chinese make another step closer to fully liberalising their currency, without completely exposing it to the international foreign exchange markets. This is similar to taking your child to the park but never letting go of his/her hand to play with the other kids. One day though the hand will be let go, but by this time, price implications/behaviour will pretty much be priced in.

“The reason for this ‘safe and gradual’ approach is to buffer the potential for any damage to the Chinese economy that a sharply appreciating currency could do. China is still very reliant on exports and the impact of an appreciating currency can have is to reduce the volume of exports, as higher prices to foreigners of goods exported from China could reduce demand.

“To surmise China continues to take ‘baby steps’, navigating a course that tries to keep international frustrations at bay while at the same time affording some protections to their economy.”

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