China floats Renminbi’s peg to US dollar

China has bowed to intense foreign pressure and growing domestic economic imbalances by revaluating the renminbi and replacing its decade-old currency peg with a more flexible exchange rate regime.

The People's Bank of China, the central bank, on Thursday announced a 2.1 per cent revaluation and a system that set the currency’s value with reference to a basket of unspecified currencies.

Since 2000, the renminbi had been trading against the dollar within the range of 8.276 to 8.28. Starting Friday, it can fluctuate by 0.3 per cent against the dollar in daily trading while moving in a wider band of 1.5 per cent, up or down, on currencies other than the dollar.

The decision is a victory for the administration of President George W. Bush, which had urged Beijing to revalue but also fended off congressional demands for trade sanctions if China refused to move.

John Snow, US Treasury secretary, said the mechanism provided “significant amplitude for the currency to move”. The Treasury would track how well it reflected underlying market conditions over time, officials said.

A senior Treasury official added: “They have not indicated that it is capped. We take them at their word at this point that this mechanism will be orientated toward market supply and demand.”

The International Monetary Fund called for maximum currency flexibility under the new system, saying it would allow Beijing to run a more independent economic policy.

The Group of Seven leading industrial nations lauded China’s decision to revalue its currency, saying it would help global economic growth.

“This more flexible exchange rate regime will contribute towards global economic growth and stability,” ministers said.

Beijing's policy change was consistent with its aim of modifying the currency system only gradually, to maintain the economy's high growth rate. The intention, the bank said, was to “promote basic equilibrium of the balance of payments and safeguard macroeconomic and financial stability”.

With China's trade surplus rising sharply and its foreign exchange reserves reaching a record $711bn last month, the bank's ambition of equilibrium in the balance of payments also suggested Thursday's small revaluation would not be the last. The bank said market developments would influence its decisions to make more adjustments to the renminbi's value.

China hopes the announcement will ease rising tensions with the US and clear the way for a successful visit to Washington in September by Hu Jintao, China's president.

Analysts said the revaluation, although small, and the introduction of more currency flexibility, would help boost consumption in China and take the steam out of rapidly growing exports, now rising by 30 per cent a year. “Both domestic fiscal and monetary policies are likely to gear towards stimulating domestic demand,” said Hong Liang, of Goldman Sachs, in Hong Kong.

The renminbi was steady at 8.11 to the dollar by midday Friday while US 10-year Treasuries recovered in Asia after yields hit a two-month high overnight. Investors were concerned that China, as it dropped the dollar peg, would begin reducing the amount of foreign exchange reserves held in US assets and debt instruments. Trading in Singapore on Friday showed, however, that the market had calmed and was seeing a fair amount of bargain-hunting.

In an immediate response to the renminbi move, Malaysia also dropped its currency peg against the US dollar and switched to a managed float against a basket of currencies. On Friday, the ringgit rose 0.46 per cent to 3.783 against the dollar by midday.

The currency, which remains untradeable offshore, was fixed at 3.8 to the dollar in 1998

Sterling still weak

The pound weakened yesterday following the release of the Bank of England minutes from the last MPC meeting that took place earlier this month.

The minutes showed that four of the nine members voted for a rate cut. The pro-change camp argued that revisions to the national accounts at the end of June had made the outlook for the economy become softer. They also noted that output growth had been below trend for three quarters, the recovery for business investment seemed likely to disappoint, and the labour market appeared to be softening.

“Overall, the risks that inflation would be below target in the medium term appeared to have risen”, they said. Make a note in your diaries for August 4th as the day when rates might be cut by 0.25% to 4.50%. As is always the case, the FX markets are already pricing this in with sterling falling to a 4-month low versus the euro and a 19 month trough versus the dollar. The yield curve now indicates that in one year’s time rates will be further below 4.50%.

At 9.30am this morning UK Retail sales for June are due for release. The BRC and CBI surveys gave conflicting messages for June, but the trend is clear, retail sales growth is fast approaching zero. Expectations are for a small rise of sales in June of 0.3% m/m which is not enough to prevent the y/y growth slowing from 1.3% to around 0.8%.

Over in the U.S. a slightly different view on interest rates is being speculated on. Yesterday the Fed Chairman Mr Greenspan made some rather hawkish comments by painting a robust picture of the economy in his semi-annual monetary policy report to Congress. Mr Greenspan foresaw sustained economic growth, suggesting no imminent pause in the Fed’s ongoing removal of monetary accommodation. While inflation is still seen as contained, he spoke of the risks to his central scenario from rising labour costs and energy prices. Worth noting that the Fed also revised up its inflation forecasts from 1.5 to 1.75% in this year and next to 1.75 to 2.0%. Interest rates look set to rise for the foreseeable future.

At 1.30 and 3.00pm our time the US release weekly Jobless Claims and Leading Indicators for June. With the latter expectations are for this to rise by 0.4% - the first increase in 6 months. Much later after European markets have closed the Philadelphia Fed index reading and FOMC minutes from the June 30th meeting are due. With the former expect a rise to a reading of 5.0 from –2.2 the previous month.

US Dollar strength continues

The prospects for US interest rates (rises) remained at the top of the agenda for financial markets yesterday as many awaited the Fed Chairman Alan Greenspan’s testimony on economic conditions to congress today and tomorrow.

Comments made by Mr Greenspan on Monday showed he felt the US economy was coping well with recent oil fluctuations. Interesting to note that global fund managers expect U.S. rates to rise to 4% before the Federal Reserve will stop tightening monetary policy – a Merrill Lynch poll showed yesterday. In its latest monthly survey of 300 portfolio global managers, Merrill found greater confidence about the outlook for the US economy in the wake of better than expected economic data.

The interest rate expectations helped push the dollar up against a host of currencies - in particular the Yen and Swiss reaching 14 and 15 month highs respectively. The euro also weakened against the greenback in spite of a strong business confidence survey from Germany’s ZEW Institute.

Just for good measure, the ZEW surged to a reading of 37 in July, well ahead of consensus expectations of 22 and the June reading of 19.5 – aided by the weaker euro, low Bund yields and stock market strength.

The pound was broadly weaker falling further against the euro and the resurgent dollar. Much of yesterday’s moves against the euro (and overnight in Asian markets by the look of it) were said to be caused by UK fund managers buying Amsterdam listed shares in Royal Dutch Petroleum ahead of the completion of the company’s merger with London listed Shell.

At 9.30am this morning attention will switch back towards UK interest rates and whether or not a rate cut could be forthcoming in early August. The Bank of England release the minutes from the last MPC meeting earlier this month. If you recall last time round the minutes showed 2 voting for a cut. All will be revealed as they say….

The US Dollar continues to grind higher.

The United States ability to fund its trade deficit received a boost yesterday in the form of the US TIC portfolio flow data for May. This release showed net demand for US portfolio securities picked up after two soft months, with overall adjusted net inflows (net of US buying overseas) rising to $56 bln from $44 bln the prior month, but with net inflows remaining sharply below levels above $80 bln observed in the first two months of the year.

On a positive note for the US dollar, inflows in May remained dominated by private sector demand, with official institutions absorbing just $13 bln or about 20% of total net inflows ($12 bln including T-bill flows).

Euro zone CPI for June was reported at a 2.1% y/y rate yesterday, in line with consensus, although the core reading retreated more than expected, falling to 1.4% y/y from 1.6% y/y.

Whilst this number on its own is unlikely to change the ECB’s current view on interest rates it does probably help to reduce the immediate pressure in terms of calls for a rate cut. Today we will get the ZEW survey of economic sentiment for Germany, another closely watched economic release

In the UK the Rightmove house price index was reported down 1% m/m yesterday, the first decline in six months. However, the RICS house price index for June was released this morning, coming out at -42 which was better than expectations of -45.

Meanwhile, the Bank of England's July meeting minutes are due tomorrow, and will be a crucial element in giving direction to the interest rate debate. Some economists believe the MPC minutes could provide some perspective of whether the question of lower rates is one of 'when' rather than 'if'. Also due this week in the UK are June retail sales and the preliminary release of Q2 GDP.

The week ahead will also see markets focus again on the outlook for Fed policy, with Chairman Greenspan delivering his semi-annual monetary policy testimony and the Fed releasing the minutes to its June 30 meeting.

While the Fed is likely to signal that tightening remains on course to continue, markets are now already pricing more rate hikes and the dollar may get further benefit if the Fed stays on message.

Dollar ends five day losing streak

The US dollar gained this week, finishing a five day losing streak after positive news on the US twin deficits and then accelerating after news of growth in the industrial sector.

The US Department of Commerce said on Wednesday that the trade gap contracted to $55.4bn in May. Meanwhile, improved tax revenues were cited by the White House as it lowered its estimates for the fiscal deficit of the US federal government to a mere $333bn from $427bn.

With little or no reaction to the weak UK house prices data overnight in Asian markets it will be interesting to see whether the European markets position early today for sterling to remain under pressure as the week unfolds.

There were two reports that came out over the weekend, both highlighting the weakness of residential property prices. Internet based agents “Rightmove” reported price growth slowed to the lowest rate of growth in 10 years. According to them prices have dropped 1.0% m/m in the month through mid-July, which cut the y/y rate to just 0.2%. This is well down from last month’s 2.4% gain and the lowest since the summer of 1995. Meanwhile the Sunday Observer reported that the July RICS survey (published after the close today) would reveal the industry body expecting no growth in property prices at all this year.

This week the outlook for the consumer (and the housing market) is a key theme of the economic data releases. June’s Retail Sales figures are due on Thursday and any further signs of weakness in consumer spending will no doubt reinforce hopes that the Bank of England will start to cut interest rates. Some clues on this might be gathered from the minutes of the MPC’s meeting earlier this month, which are due for release on Wednesday. With downward revisions to GDP – the Q2 1st estimate is due on Friday – and a fall in employment are all likely to have convinced some members (more than 2 last time) to have voted for an immediate cut. Needless to say a 5-4 vote should go a long way to confirm that on the 4th August interest rates will move down to 4.50.

Meanwhile in the U.S. Mr Alan Greenspan the Federal Reserve Chairman will take centre stage when he delivers his monetary policy report to the House Financial Services Committee on Wednesday at 3.00pm our time. As usual, his testimony will be scrutinised particularly the mantra of a measured pace in interest rate rises is repeated. Other data that could cause a stir for the stronger dollar will be today’s TICS capital inflow numbers for May and later in the week the Leading Indicators for June, Philadelphia Fed survey and the FOMC minutes (June 30th).

In the Eurozone, analysts will hope to see a further improvement in the German ZEW business survey of economic conditions due tomorrow. E-Z Industrial Production figures for June are also due. This rose by 1.7% last month, which was better than expected. Can this be sustained? If both releases show further gains then the euro could receive a small boost.