Forex Investment and Currency Trading

The CNY should appreciate by 10% pace in 2008. But a one-off revaluation looks ever less likely. The authorities are turning increasingly cautious in the face of slower export growth and a stabilizing trade surplus. Inflation is not yet a large enough concern to justify a significantly faster pace of appreciation.

China’s economy is showing signs of cooling. It’s early days, and the economy may yet reaccelerate. But policy tightening and weaker global demand are starting to weigh on growth. China has not decoupled. Exports slowed convincingly in Q4. However, domestic demand is relatively robust as underscored by the strength of imports for domestic consumption. Domestic demand will be supported by still strong spending in utilities, rail, and low-cost housing construction and the trade surplus will stabilize.

Inflation remains high. February’s CPI spiked 8.7%y/y after snowstorms disrupted food supplies temporarily. Inflation is expected to remain above 7.0%y/y in Q2, before easing in H2 as the base of comparison rises. But there is a risk that the snowstorms have damaged the winter wheat crop. If so, inflation is expected to start rising sharply. Note that wheat prices were the main driver of high inflation in 1989, 1994, and 2004.

The PBOC has few monetary policy options to tackle food prices. Instead, it will focus on capping inflation expectations. PBOC will likely wait several months in order to determine if the rise in the CPI slows as food supply disruptions ease. H1 is forecasted no change in interest rates, more 50bp hikes in the required reserve ratio and a selective easing of earlier imposed credit quotas. Faster CNY appreciation means the leadership is tolerant of a stronger CNY. However, the State Council still includes powerful opponents, while US recession fears will aggravate concern about jobs growth in the export manufacturing sector. Expect the annualized pace of appreciation to return to 10% in coming months.