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Saturday 1 October 2016

Global markets rocked as China cuts yuan again

Published 13/08/2015 | 02:30

Yuan's second devaluation in two days does not signal a trend regarding the economy, the country's central bank says
Yuan's second devaluation in two days does not signal a trend regarding the economy, the country's central bank says

China surprised global financial markets by devaluing the yuan against the dollar for the second consecutive day yesterday, sending stocks around the world lower.

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The move sent shockwaves through Asian markets and sent European shares lower.

So called safe haven assets including the US dollar, Treasuries and gold gained. China's central bank tried to reassure investors yesterday by saying the second cut was not the start of a sustained depreciation.

Nonetheless, the move spooked investors, with European stocks falling the most in a fortnight, led by carmakers and luxury goods sellers. Chinese stocks slumped in Hong Kong trading.

By lunchtime yesterday, the FTSE was down 1.3pc, Germany's DAX had dropped 2.4pc and France's CAC 40 had lost 2.5pc. The Hang Seng China Enterprises Index slid 2pc at the close.

The People's Bank of China dropped the so-called daily fix around which the currency trades against the dollar by 1.6pc yesterday, following the 1.9pc adjustment on Tuesday. The central bank signalled that the rapid drop in the yuan's value in the past two days wouldn't become a trend.

"Looking at the international and domestic economic situation, currently there is no basis for a sustained depreciation trend for the yuan," it said.

The initial decision to devalue the yuan, or renminbi, followed weak economic data, including a drop in China's exports in July of more than 8pc, fuelling concerns of an economic slowdown.

It's likely that a cheaper yuan will help boost Chinese exports by making them less expensive.

But the move makes it more expensive for countries, such as the US in particular, to sell into the Chinese market, and sparked speculation as to whether the Federal Reserve might postpone its much anticipated interest rate rise expected possibly as soon as next month. Analysts had mixed views on the move by Beijing. David McNamara of Davy Stockbrokers said the devaluation was small in comparison to previous major global devaluations, and said it may not yet be enough to persuade the Fed to hold off on a rate rise in September.

"Nonetheless, the deflationary impacts of lower import prices from China could persuade other central banks to loosen monetary policy," he said.

Ratings agency Standard & Poor's struck an upbeat tone, stating Beijing's move "makes good economic sense and is not the start of a currency war or an attempt to jump-start growth."

"The argument that China is trying to spur growth by weakening its currency to drive exports does not strike us as very convincing," S&P's Asia-Pacific economist Paul Gruenwald said.

"Exports are more a function of foreign demand, with the exchange rate playing a secondary role. There is no reason for that relationship to have changed."

The International Monetary Fund said China's move to make the yuan more responsive to market forces appeared to be a welcome step, and that Beijing should aim to achieve an effectively floating exchange rate within two to three years.

S&P said Beijing was effectively giving the IMF what it wanted.

"We see the timing as opportune. This is because China can now say that by moving to a more market-determined rate, it is delivering what the IMF and US Treasury have been asking for.

"Having more exchange rate flexibility is palatable to the Chinese authorities," added Mr Gruenwald.

London-based Lombard Street Research said the move could have damaging effects for emerging markets, arguing the combination of a higher dollar and a cheaper yuan may be painful if an economy is compelled to reduce its external funding needs.

Q & A

What has China done?

China's authorities have taken a shock decision to let the value of the yuan - also known as the renminbi - slide against the US dollar over the last two days. The first announcement on Tuesday of 1.9pc was the biggest one-day drop in the currency's value since January 1994.

China said Tuesday's devaluation would be a one-off. Why is Beijing doing this?

That's hard to say for sure. Analysts have mixed views on whether the devaluation efforts are driven by China's desire to boost its exports by making it cheaper for overseas markets to buy them, or to attain reserve currency status at the International Monetary Fund.

Beijing has been lobbying the IMF to include the yuan in its basket of reserve currencies known as Special Drawing Rights, which it uses to lend to sovereign borrowers. This would mark a major step in terms of international use of the yuan.

How can such a move help the Chinese economy?

A cheaper yuan will help exports by making them less expensive on overseas markets. China's Ministry of Commerce acknowledged yesterday that the depreciation would have a stimulative effect on exports.

What's been the reaction of the world's biggest economy, the US?

It hasn't taken it very well. On Tuesday, US politicians accused Beijing of making a grab for an unfair export advantage. Chinese President Xi Jinping is due to visit Washington next month, and you can bet the devaluation will be top of the list of topics to be discussed.

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