Bank tipped to ease yuan's peg to U.S. dollar

The People's Bank of China may allow the yuan to fluctuate more against the US dollar in a few weeks to check inflation, according to Standard Chartered Bank analysts.

The central bank refused to comment on the report.

Standard Chartered foreign exchange strategists Robert Minikin and Callum Henderson have written in a report that the People's Bank of China could widen the daily US dollar-yuan trading band - a formal exchange rate range the central bank is required to maintain - as it 'could create the conditions for modestly faster yuan appreciation in the near term to temper persistent inflation'.

The range could be expanded to as much as 1 per cent on either side of the daily central parity rate set by the PBOC, up from 0.5 per cent now, the report predicts.

That would mean the yuan could appreciate or depreciate against the US dollar by as much as 2 per cent on any given day. The report, however, adds that the yuan is unlikely to see a big one-off revaluation as officials have ruled out such a possibility and the global economy is slowing.

Economists expect the yuan to trade on the strong side of the dollar-yuan band if the PBOC widens it in the short term. In the long term, though, such a change would help check speculation, curb hot money inflow and ease the foreign exchange reserves by arresting the yuan's one-way movement against the US dollar, said Liu Ligang, head of China economics at ANZ bank.

China's large foreign reserves, mostly in US dollars, has contributed to soaring inflation. Guan Tao, a senior currency regulator at the State Administration of Foreign Exchange, warned of the economic and political risks 'in excessive holdings of US dollar assets', in comments that briefly weakened the US dollar yesterday.

Liu said the PBOC should expand the trading band to as much as 3 per cent on either side of the central parity rate. The yuan is allowed to fluctuate by up to 3 per cent on either side of the reference rates against the euro, yen and Hong Kong dollar.

'The central bank has been talking about reforming the yuan exchange rate regime for a long time but so far, progress has been too slow,' said Liu.

Beijing began to liberalise the yuan exchange rate in 2005. It has been more than three years since the central bank widened the band to 0.3 per cent on either side of the daily central parity rate.

Lu Zhengwei, chief economist at the Industrial Bank, said China's policy of using a basket of currencies to determine the value of the yuan has not been working as the US dollar continues to drive the yuan.

'A change of 0.3 per cent to 0.5 per cent in three years is just too slow,' said Lu, adding that he had recommended the band be broadened to 1 per cent a year ago.

Other experts said it was likely the central bank would want to broaden the band a year after it vowed to increase the flexibility of its exchange rate on June 19 last year.

But even if Beijing does broaden the band, it does not necessarily mean the exchange rate will become more volatile. Minikin and Henderson said 'onshore trading of [US dollar-yuan] has been orderly', with the gap between the daily high and low averaging just 0.1 per cent in May. Lu said that while it was unclear why the gap had remained small, low trade volumes and a declining appetite for risk could be part of the explanation.