Foreign Exchange

Thursday, June 21, 2012 - 02:26

Analysis: China PBOC Defends Yuan But Selling Pressure Mounts


-- PBOC Tells Banks To Support Spot As Yuan Hits Bottom Of Trade Range

BEIJING (MNI) - Another day, and more yuan weakness.

Analysts still broadly expect the Chinese currency to notch up another gain against the U.S. dollar this year.

But with half the year nearly gone -- and no sign of any meaningful recovery in global sentiment -- it's becoming increasingly difficult to see what will drive the yuan higher in the months ahead.

The currency fell 0.96% relative to the central parity in the Thursday session to 6.3650, one of the biggest intraday fall since the daily trading band was widened to 1% on April 16. Offshore yuan has also weakened sharply, also falling to 6.3645 from the previous close at 6.3570.

An immediate cause for today's weakness was the release of HSBC's June flash PMI, which showed Chinese manufacturing conditions hitting a seven-month low in the face of sluggish domestic and global conditions.

That was just the latest in a stream of data points highlighting the suffering at the industrial level (though HSBC typically provides the most bearish reading among the monthly surveys).

But the currency has been under pressure for far less in recent weeks. Citi FX strategist He Weisheng said the sell-down has been fueled by Chinese corporates meeting the demands of deleveraging European banks, but also said dollar demand may be stoked by low commodities prices.

Data earlier this week showing small net foreign exchange purchases in May -- suggestive of capital inflows -- were widely dismissed by analysts as a blip, noting the bearish mood in global markets and the yuan's consistent intraday weakness.

Based on its central parity fixing, the currency is down around 1% against the dollar since the start of this year, putting the yuan on track to record its first year of depreciation since it was originally depegged in July 2005.

The yuan has risen 1.21% in real effective terms this year through the end of May, according to Bank for International Settlements data, indicating that Beijing could be more closely targeting a currency basket in guiding the exchange rate.

But dollar-yuan remains in focus, and analysts still expect some appreciation over 2012, following 2011's 4.7% rise.

"We're still looking for some recovery if the market stabilizes," said Frances Cheung, a strategist with Credit Agricole CIB in Hong Kong.

She said the yuan may rise to 6.20 by the end of this year, but acknowledged that the risks remain on the downside given global conditions.

Despite the bearish mood, the PBOC has been holding the line in interday trading, moving the yuan back towards 6.3000 at the fixing, only for the currency to gap down instantly at the morning open.

China Merchants Bank analyst Liu Dongliang said the PBOC has explicitly asked big state lenders to support the yuan spot in intraday trading, but also noted the challenge it faces.

"There's no motivation to go long the yuan -- both clients and banks want to hold dollars," he said.

As long as the mood remains negative, there's little upside for the yuan, though Citi's He also said that politics is prompting the PBOC to defend the exchange rate at current levels.

Global pressure on China to strengthen the currency is fading as the country's current account surplus falls.

IMF deputy managing director John Lipton said in Beijing earlier this month that the yuan is now "moderately undervalued" against a basket, marking a significant ratcheting down of the fund's previous "substantially undervalued" formulation. G20 leaders also welcomed China's recent commitment to increase the role of market forces on its continued reform of the exchange rate.

Despite a temptation among policy-makers to allow the currency to weaken against the dollar to cushion exporting firms, political sensitivities, not least November's U.S. presidential elections, preclude outright depreciation.

"There's not much upside but not much downside," said Citi's He. "Unless there's a really big sell-off -- such as euro going to parity -- I think dollar-yuan will go higher in 2012."

The dollar's movements dominate, though, and China Merchants' Liu believes it is "very possible" to see the cross at 6.4000 or below if the greenback remains strong.

beijing@marketnews.com **MNI Beijing Newsroom +86-10 8532 5998**

[TOPICS: M$Q$$$,M$A$$$,M$$FX$]

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