What Europe’s coronavirus woes mean for the yuan-euro exchange rate

European governments are still struggling to suppress a Covid-19 pandemic that Beijing now seems to have contained. The policies of the two central banks are also a study in contrasts

Neal Kimberley

Published: 7:45pm, 3 Nov 2020

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Traders who see further gains for the yuan on foreign exchanges don’t need to focus exclusively on the level of the renminbi versus the US dollar. The euro-yuan exchange rate is a case in point. There is every possibility the renminbi could strengthen further against the euro.

In the first instance, the contrast between the euro-zone economy and that of China is striking. With European governments still struggling to suppress a Covid-19 pandemic that Beijing now seems to have contained, the euro-zone economy is in poorer shape than China’s, which is showing growing signs of recovery.

Admittedly, data released on October 30 by the European Union’s statistics office, Eurostat, showed that gross domestic product in the 19-country euro zone had expanded by 12.7 per cent quarter on quarter in the July-September period following a second-quarter slump of 11.8 per cent.

France, Italy and Spain posted quarterly GDP growth of between 16.1 and 18.2 per cent while Germany, the largest economy in the euro zone, registered an 8.2 per cent expansion quarter on quarter, although Berlin still expects that as a consequence of the pandemic, the German economy will have contracted by 5.5 per cent over 2020.

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But this third-quarter data arguably flatters to deceive. Such is the scale of rising infections from the pandemic in the euro zone that member-state governments are reintroducing tighter controls. They ma be short of a total lockdown, but nevertheless they are bound to have a marked economic impact.

For example, Germany has gone into a partial lockdown that will currently last until November 30. “November will be a month of truth. The increasing numbers of infections are forcing us to take tough countermeasures in order to break the second wave,” said German Finance Minister Olaf Scholz last week.

France, too, has entered a partial lockdown that, at the moment, will continue until December 1. While French President Emmanuel Macron stressed last week that public services and factories would stay open, and the French economy “must not stop or collapse”, he also said France must now “brutally apply the brakes” to avoid being “submerged by the acceleration of the epidemic”. Spain, meanwhile, has declared a state of emergency that is set to last until May 9, 2021.

A couple sit among thousands of Spanish flags, representing the Spanish victims of Covid-19, on Patacona beach in Valencia on October 4. Spain surpassed one million virus cases on October 21, according to health ministry figures. Photo: AFP

Meanwhile, China continues to see an economic recovery from the 6.8 per cent GDP contraction in the first three months of 2020. Second-quarter growth of 3.2 per cent was followed by a 4.9 per cent expansion in the third quarter. Indeed, despite the pandemic, Beijing now forecasts China’s GDP to top 100 trillion yuan (US$15 trillion) in 2020.

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With the coronavirus still wreaking havoc in the euro zone, the European Central Bank has understandably sought to be as supportive as possible. ECB monetary policy remains ultra-accommodative. An already negative benchmark interest rate has been bolstered by large-scale asset purchases but even easier policy is being considered.

“The euro area economic recovery is losing momentum more rapidly than expected, after a strong, yet partial and uneven, rebound in economic activity over the summer months,” ECB president Christine Lagarde admitted on October 29, noting that all of the ECB Governing Council agreed “that it was necessary to take action and therefore to recalibrate our instruments” at their next policy meeting, scheduled for December 10.

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The ECB’s stance contrasts markedly with that of the People’s Bank of China. With China’s economy seemingly recovering, China’s central bank doesn’t face the same predicament as the ECB but nor does the PBOC seem too convinced about the merits of going down the ultra-accommodative monetary policy path.

In fact, the PBOC has taken a more nuanced approach to monetary policy easing throughout the pandemic. “Implementing a normal monetary policy, [namely] a positive interest rate and a rising yield curve, is good to provide incentives for market entities and promote sustainable development of the economy and society,” PBOC governor Yi Gang wrote in an article published by China Finance magazine on October 10.

“We need to maintain reasonable liquidity, money supply and aggregated financing, but must say no to a flood of money at the same time. Instead, we should target growth near potential productivity and avoid economic fluctuations,” Yi said.

A pandemic-stricken euro-zone economy is struggling, and the ECB’s already ultra-accommodative policy settings are set to become even looser. China’s economy is showing signs of recovery, and the PBOC is extolling the virtues of a positive interest rate and a rising yield curve.

The currency markets may well conclude that the yuan should strengthen further against the euro.

Neal Kimberley is a commentator on macroeconomics and financial markets

This article appeared in the South China Morning Post print edition as: Europe’s woes could see yuan strengthen further against euro

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