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Currencies

Yuan hits three-month high after China hints at tighter monetary policy

Beijing to curb risky lending despite spectre of slowdown in economic growth

PUBLISHED : Thursday, 21 December, 2017, 5:46pm
UPDATED : Thursday, 21 December, 2017, 10:54pm

The yuan rose to its highest level against the US dollar in three months on Thursday, after China’s Central Economic Work Conference triggered expectations of tighter monetary policy and cuts to risky lending in financial markets and the economy.

“China will fight the critical battle of addressing major risks, with the priority on managing and preventing financial risk over the next three years,” according to a statement carried by state news agency Xinhua, at the conclusion of the three-day closed-door meeting.

The comments suggest the government is determined to deleverage financial markets and the economy, to cut down on risky lending behaviour despite it leading to a slowdown in economic growth, and point to further tightening of monetary policy, analysts said.

Five key facts about China’s economic conference

“It looks like the case of a higher yuan next year, as expectations are growing for tighter monetary policy,” said Jimmy Zhu, chief strategist at online brokerage Fullerton Markets. “Tighter policy and less liquidity favours its own currency.”

Reflecting expectations of tighter liquidity conditions and higher interest rates, the onshore yuan jumped to 6.5712 against the US dollar on Thursday, its highest level since September 20. The currency has appreciated by 5.3 per cent this year versus a depreciation of 6.9 per cent last year.

The People’s Bank of China also raised its daily reference rate by 0.41 per cent, the biggest daily increase in a month, to 6.5795 per US dollar on Thursday. Traders are allowed to trade up to 2 per cent on either side of the mid point for the day.

Sean Yokota, head of Asia strategy at Swedish bank SEB, said in a recent research note that China’s No. 1 risk was the size and growth of its debt. The bank estimates that China’s debt currently stands at about 260 per cent of its gross domestic product versus less than 150 per cent 10 years ago, which suggests there was a slowdown in debt growth but that it has not really been deleveraged.

As deleveraging starts, bond yields might face upward pressure that will in turn attract foreign investment and support or even strengthen the yuan, said Yokota. The central bank will also want to support the currency, acting as an anchor during the deleveraging process amid market volatility, he added.

China’s bond yield curve has been shifting upwards this year in reaction to tighter liquidity conditions, and also in anticipation of tighter policy going forward. The 10-year government bond yield has surged from 3.6 per cent to more than 4 per cent in the past two months.

The yuan’s strength might also attract foreign capital to the domestic bond and equity markets, and gain inclusion in global bond and equity indices in 2018.

“The steady exchange rate will provide a window of opportunity for China to open up its onshore financial markets with more balanced flow,” Mizuho Bank said in a research note on Thursday.

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