Forex Investment and Currency Trading

1 – 3 Month Outlook – CNY

China’s FX reserves soared by a massive $128.4bn in the first four months of the year as the authorities sought temporarily to stabilise the USD/CNY rate. Latterly, however, the Chinese currency has begun to appreciate once again, breaking below the 6.9 level. This positive trend is expected to continue in the short term.

6 – 12 Month Outlook – CNY Consistent appreciation
The full breakdown of 2007 nominal GDP by expenditure presents a picture of gradual growth rotation towards domestic demand and in particular a greater role for private consumption in the economy’s expansion. Especially noteworthy was the positive impact of higher agricultural prices on rural incomes and outlays. In contrast, the contributions from fixed asset investment and net exports, while still high, have slowed significantly since 2005. As far as this year is concerned, real GDP growth amounted to 10.6% yoy in Q1, down from 11.9% in Q407. Meanwhile, the latest macro numbers continue to be consistent with a modest slowdown in real GDP growth for 2008 as a whole.

Inflation remains the dominant policy issue in China. Although, the headline CPI rate declined to 7.7% in May from an average of 8.5% over the three previous months, the residual effects of the appalling winter weather and the Sichuan earthquake on agricultural output and transportation are likely to keep inflation above 7.0% in the months immediately ahead. However, more notable relief is likely later in the year as a result of favourable base effects and improved food supply. This is reflected in the fact that the authorities recently felt able to sanction diesel fuel and electricity price hikes.

The government is keen to bring real deposit rates into positive territory over the medium term, but for now, the dominant means to bear down on inflation is likely to be a more rapid appreciation of the yuan. However, increases in reserve requirements are likely to continue as a means to mop up excess liquidity. Over the 12-month horizon, USD/CNY is likely to fall through the 6.50 level and could dip as low as 6.30, depending on the success of the flight against inflation.