China's shock currency move sends European stocks lower
China devalued its currency yesterday after a run of poor economic data, sparking fears of a global currency war.
Officials said the currency move, which makes it cheaper for Chinese firms to sell their goods abroad, was a free-market reform. However, economists suspect it could be the beginning of a longer-term slide in the exchange rate.
The move triggered the biggest one-day fall in China's yuan since a massive devaluation in 1994 when China aligned its official and market rates.
In Europe the shock move sent carmakers and luxury-goods shares lower on the markets.
BMW and Daimler fell more than 3.7pc each, LVMH Moet Hennessy Louis Vuitton and Swatch Group slipped at least 3.5pc and Jameson maker Pernod Ricard and its rival Remy Cointreau led losses in food-and-beverage shares.
It happened after China's central bank set its official guidance rate down nearly 2pc to 6.2298 yuan per US dollar - its lowest point in almost three years - in what it said was a change in methodology to make it more responsive to market forces.
"Since China's trade in goods continues to post relatively large surpluses, the yuan's real effective exchange rate is still relatively strong versus various global currencies, and is deviating from market expectations," the Peoples Bank of China said.
"Therefore, it is necessary to further improve the yuan's midpoint pricing to meet the needs of the market."
The PBOC is China's central bank. It called the move a "one-off depreciation", but economists disagreed over the significance of a move that reversed a previous strong-yuan policy that aimed to boost domestic consumption and outward investment.
Devaluing the currency should boost Chinese exports, but will hurt not only global firms selling into the world's second biggest market but also Chinese borrowers who owe money to international banks.
The move flies in the face of China's previous policy of targeting consumption at home as an economic driver.
"For a long time, I gave the PBOC credit for holding the line on the renminbi (yuan) and recognising that while it might be tempting to try to shore up the old-growth model by devaluing the currency, that really was a dead end," said fund manager Patrick Chovanec of US-based Silvercrest Asset Management.
He said a strong yuan was needed to force China toward consumption and away from low-end manufacturing.
"What the world needs from China is not more supply; what it needs is demand."
The devaluation followed weekend data that showed China's exports tumbled 8.3pc in July, hit by weaker demand from Europe, the United States and Japan, and that show producer prices were well into their fourth year of deflation.
The move hurt the Australian and New Zealand dollars and the Korean won, fanning talk of a round of currency devaluations from other major exporters - a so-called currency war.
But some of Asia's most interventionist central banks appeared to be holding their nerve on currency policy.
"I don't think the move would trigger a global currency war," a Japanese policymaker said.
Economists pointed out that until yesterday, China had held the yuan firm while its neighbors had debased their currencies.
While a weaker yuan will not cure all the ills of China's exporters, which suffer from rising labour costs and quality problems, it would help relieve deflationary pressure, a far bigger economic concern in the view of some economists.
Falling commodity prices have been blamed for producer price deflation, putting China at risk of repeating the deflationary cycle that blighted Japan for decades.
Growth in China has slowed markedly this year and is set to hit a 25-year low even if it meets its official 7pc target.
The devaluation hit shares in Asia and Europe. Chinese airline stocks also fell, given the impact higher fuel prices would have on their bottom line, though exporter stocks rose.
Some said the move was also to blame for a fall in futures contracts tracking the S&P 500 index, given the potential hit to US exports to China.
In the past, the PBOC set the midpoint for yuan trading by a formula based on a basket of currencies, but the methodology was never publicised and many believed the midpoint was frequently used as a way to bend the market to policy goals.
Some economists said the devaluation was also designed to support Beijing's push for the yuan to be included in a basket of reserve currencies known as Special Drawing Rights (SDR), which are used by the International Monetary Fund to lend money to sovereign borrowers.