China’s yuan dilemma: Beijing ‘faces a choice’ between cutting rates and a weakening currency

Depreciation pressure on the yuan may constrain China’s ability to expand monetary policy in the second half of the year, say experts

Combination of slowing growth in China and a strong dollar due to aggressive US tightening predicted to weigh on the yuan outlook

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China’s central bank may be concerned about cutting interest rates too low, given the widening yield differential between China and the US, analysts say. Photo: Kyodo

Published: 8:00pm, 8 Sep 2022

The People’s Bank of China (PBOC) is walking a tightrope between monetary easing to shore up economic growth and keeping depreciation of the yuan “under control”, amid growing policy divergence with the United States and possible complaints from Washington about China’s weakening currency.

The US Federal Reserve’s aggressive rate hikes to rein in inflation this year have driven the US dollar stronger against many currencies. So far, it is up 9.5 per cent on the yuan, 13.7 per cent against the euro and 24.9 per cent on the yen.

As China’s economic growth sputters, Beijing has reason to expand fiscal and monetary policies in the second half of the year. But the PBOC may be concerned about cutting interest rates too low, given the widening yield differential between China and the US, analysts said.

“The US is raising rates, if China’s monetary policy continues to ease, naturally there will be more depreciation pressure on the yuan, there may form some constraints to monetary policy. But so far, I don’t think the constraint is too significant,” said Xu Gao, chief economist of Bank of China International in a blog post published by CF40 Forum last week.

In the medium to long term, China is still facing the choice between interest rates and the foreign exchange rate

Liang Zhonghua

Liang Zhonghua, macro analyst at Haitong Securities, said the PBOC is likely to maintain its easing stance, while keeping depreciation of the yuan “under control” by deploying tools such as the foreign exchange reserve requirement ratio and capital control measures.