Chinese industrial output in October accelerated at its fastest rate in seven months, according to figures released on Wednesday.
Analysts are now cautioning that sort of rebound will only heighten pressure on China to appreciate its currency versus the US dollar as exports rebound and domestic focus once again is forced to turn to inflation.
Jian Chang at Barclays Capital, for one, expects the world’s third largest economy to break away from the close range it’s been tracking versus the dollar as soon as 2010. The likes of RBC Capital Markets agree.
Here, meanwhile, is a chart from Barclays Capital reflecting just how disconnected the Chinese yuan’s nominal effective exchange rate has now got versus the USD/CNY spot rate:
With consensus now turned to when rather than if yuan appreciation happens, the question most analysts are asking is how China may go about implementing such a move. Will it be a short and dramatic break-off? Or can we expect a more prolonged incremental phasing in?
According to Barclays Capital these are the three most likely scenarios :
A one-step significant appreciation is a small probability event. A potential advantage of this approach is to kill appreciation expectations and speculative inflow pressures, but it is difficult to know what would be the required size of appreciation, and the authorities will be mindful of the adverse effect on the economy.
Any weakening in USD/CNY will initially be associated with weaker USD cross rates. We have already seen a slight weakening of USD/CNY owing to USD weakness in recent months. The reference to a basket is likely to rise as pressure for currency appreciation increases.
NEER appreciation — that is, a weaker USD/CNY when USD cross rates are stable or strengthening — is likely to take place when inflation and overheating concerns develop into its advanced stage. We are unlikely to get into that situation before H2 10, in our view.
Of course as BarCap rightly remind in the last round of policy tightening in 2007-08, currency appreciation was also initially associated with USD weakness and NEER appreciation only started in the first part of 2008 as inflation became a major concern.
Related links:
Dollar rise *alert* – FT Alphaville
The US debt to GDP balance, and China - FT Alphaville