LONDON: Any shift in US monetary policy looks likely to be gradual and this could press China to quicken the pace of the yuan's rise, in turn putting the dollar under even more pressure.
A weaker dollar means China has to buy more of the US currency to curb the yuan's strength, leading to a build-up of its FX reserves and a likely diversification which will only exacerbate the dollar's decline.
With the culmination of a second round of asset purchases by the Federal Reserve in June, a bearish dollar bias has been evident before the April meeting of the Federal Open Market Committee, which concludes on Wednesday.
While there still appears to be a balance on the board of the central bank, the doves have been the more vocal of late.
If there is to be a change in US monetary policy then the majority of economists and analysts seem to concur that any shift will only happen slowly.
Before any actual rate hike, the consensus is for the Fed to maintain its promise of accommodative policy for "an extended period" for some time, and that it will be even longer before it reduces its balance sheet
Sustained easy monetary policy in the United States will continue to weigh on the dollar, though recent references to a strong dollar from European Central Bank chief Jean-Claude Trichet, and US Treasury Secretary Tim Geithner have raised interest in the Fed chairman's view on the US currency.
However, the current level of the dollar is unlikely to influence Ben Bernanke to change his view in his first news conference on monetary policy later on Wednesday.
As recently as March 1 he said the US central bank is not debasing its currency, and the dollar was roughly the same value as before the financial crisis . The dollar has fallen further, but its 4 percent decline since March 1 may do little to alter his opinion.
It may be more likely that increasing efforts by US politicians to tackle the gargantuan budget deficit will require that easy monetary policy be maintained for longer in order to offset any fiscal tightening.
There is already broad agreement that greater debt reduction is required if the United States is to keep its AAA credit rating. Standard & Poor's has already warned on the US outlook and this is putting even more pressure on the dollar.
Given that US growth has undershot expectations, and improvements in the jobless rate are partly put down to a fall in labour market participation, continued easy monetary policy may prove vital in maintaining the modest US rebound.
Continued ultra-easy policy in the United States poses increasing problems for China, where officials have said US policy will pressure the dollar. This would weigh on USD/CNY.
CHINA
Whilst China has allowed the yuan to rise more quickly to prevent unwanted imbalances, the managed float has still led to regular intervention.
This has driven the foreign exchange reserve to more than $3 trillion -- a level viewed as excessive by People's Bank of China governor Zhou Xiaochuan, who believes further diversification is required.
His comments come when the PBOC is widely perceived to be using a stronger yuan to help tame imported inflation.
That said, the pace of yuan gains, whilst historically rapid, are woefully short of the appreciation required just to match the dollar's decline this year.
In 2011 the dollar index has fallen more than 7 percent. Dollar/yuan has declined barely 1 percent. If China is to prevent the continuing rapid growth of its foreign exchange reserve, then a much faster pace of yuan gain is required.
Whilst official language suggests a yuan revaluation is out of the question, a widening of the currency's trading bands, and a faster managed appreciation may be more likely.
If so, the dollar looks set to weaken broadly against Asian currencies.
Although stronger currencies are likely to suit the region's battle against inflation, they are also likely to bring more dollar-buying intervention, and that will lead to further diversification of reserves.
Indeed the whole pattern appears self-sustaining.
Rather than the end of quantitative easing in the United States sparking a dollar revival as was assumed by some, the US currency may be on the cusp of an even faster decline, fuelled by ever larger adjustments of central bank reserves triggered in turn by the greenback's decline
Comments
Comments are closed.