China takes steps to strengthen currency

Yesterday, China’s central bank set the guidance rate at 6.4010 per US dollar, weaker than the previous fix of 6.3306.

Flickr/Bob AdamsFirst it was a stock market meltdown, now it’s a weakening currency.

In a note published on Tuesday, after the first devaluation of 2 percent was announced, the PBoC said that monetary policy would now allow the currency to float and trade more freely, in a move towards a more market-orientated approach.

PBOC Governor Yi Gang said on Thursday that the central bank had already withdrawn from regular intervention but would implement effective management of the exchange rate in case of extreme currency volatility.

What has really unnerved markets, however, is the fear that central banks around the world could be hamstrung by persistently weak inflation, and unable to counter growth or financial shocks that might be coming down the road.

“The engineered part of the devaluation seems to be over, but since market forces are meant to play a larger role, the yuan would drift lower”, wrote analysts at Brown Brothers Harriman.

“The central bank is capable of keeping the exchange rate basically stable at an adaptive and equilibrium level”, Zhang said. The Chinese move also drove investors to push back their expectations of when the U.S. Federal Reserve would raise interest rates, helping drive the dollar index to a one-month low of 95.926.

The yuan’s fall could complicate matters for the European Central Bank in the quarters ahead, Standard & Poor’s economists said in a report Friday. He also said China would continue on its own schedule to open the country up to freer cross-border capital flows despite recent market fluctuations.

The news conference was an unusual event for an organization that rarely puts a public face forward and typically communicates through lengthy messages on its website, sometimes posted well into the evening.

China’s rivals see it as a way to boost exports and prop up the market.

Previously, authorities based the rate on a poll of market-makers, but will now also take into account the previous day’s close, foreign exchange supply and demand and the rates of major currencies.

Benchmark US crude rose 20 cents to $43.50 in electronic trading on the New York Mercantile Exchange.

While a limited yuan devaluation shouldn’t greatly change the eurozone’s inflation outlook, S&P said, the reaction in emerging markets is critical.