June 21, 2010 / 12:23 AM / 9 years ago

China loosens currency grip as G20 summit looms

SHANGHAI (Reuters) - China’s surprise move to relax currency controls ahead of this weekend’s G20 summit buoyed global markets and sent the yuan to a five-year peak on Monday, but caution returned as analysts questioned how far Beijing’s new currency flexibility would go.

An clerk counts yuan banknotes at a bank in Hefei, Anhui province, June 20, 2010. China will gradually make the yuan's exchange rate more flexible, the central bank said on Saturday, indicating that it was ready to break a 23-month-old U.S. dollar peg. REUTERS/Stringer

Stock markets surged after China loosened the yuan’s 23-month-old peg to the U.S. dollar, easing a policy aimed at steadying its economy during the global downturn and paving the way for the currency to appreciate over the long-term as demanded by the United States and other major trade partners.

The unexpected move sent the yuan up 0.42 percent to 6.7976 per dollar on Monday, both the biggest daily gain and the highest close since China revalued the currency and introduced a managed float regime in 2005.

But initial optimism was quickly tempered with caution as officials, analysts and investors sought to determine the extent of China’s willingness to rethink policies which have turned it into a global export powerhouse.

“We’re obviously encouraged, but we’ll be monitoring the progress,” White House spokesman Bill Burton said in Washington. “Implementation here is going to be key, and so we’re just going to be keeping an eye on that.”

A senior U.S. official, briefing reporters on condition of anonymity, said China’s gradual approach to yuan flexibility was a prudent step that could both manage expectations and deter massive speculative buying of Chinese assets.

The official said it was promising that China seemed ready to allow the exchange rate to respond to market forces, and that the test now was how far and how fast Beijing would permit the yuan to move.

U.S. stocks, which had risen in step with world markets on the new yuan policy, succumbed to late-day selling and ended fractionally lower as an overall bearish tone undercut the early news out of China.

“Markets were unable to sustain that euphoria as they looked into the details,” said John Brady, senior vice president at MF Global in Chicago.

China’s central bank ruled out a one-off revaluation of yuan and suggested it was close to fair value — a hint change will be gradual and may not satisfy critics who say China keeps its currency artificially undervalued by as much as 25 to 40 percent in order to gain unfair trade advantage.

The currency issue is likely to feature at the summit of the Group of 20 nations in Canada on June 26-27, with many expected to seek further clarification from Beijing.

“Some countries will want to see more detail and perhaps even a schedule of some sort,” Canadian Finance Minister Jim Flaherty told reporters in New York on Monday.

Despite the Chinese move, G20 leaders were expected to encounter further divisions over strategies to rebalance the global economy — a top G20 goal since the global financial crisis of 2007-2009.


With pressure high from industry groups who want to see China’s huge trade surplus brought down fast, China’s sharpest critics in the U.S. Congress were also unlikely to be mollified.

“China’s action to allow the yuan to rise slightly today is a drop in a huge bucket. And the truth is, we’ve seen China take actions like this before when the spotlight is on, and then revert back to old tricks,” Senator Sherrod Brown, a Democrat from Ohio, said in a statement.

Nevertheless, Beijing’s move on the yuan — although small by comparison with freely floating currencies — provided an unexpected boost ahead of the G20 meeting.

The People’s Bank of China (PBOC), after setting the mid-point for Monday’s trading range, let the yuan rise at one point as much as 0.47 percent, just shy of the 0.5 percent limit which had been rarely tested in the past.

Traders said it was unlikely the yuan would see gains on the same scale in coming days, with Tuesday’s mid-point setting serving as an important barometer of how much more appreciation the central bank is willing to stomach.

China’s economic strength gave policymakers confidence to ease the peg, but they remain worried demand for China’s exports is not on a solid footing given risks like Europe’s debt woes.

Chinese Commerce Ministry spokesman Yao Jian told the official Xinhua news agency that yuan reform could put pressure on exports initially, as firms were likely to face higher material costs, but would yield long-term benefits.

The Chinese move may also cut pressure on the Obama administration to formally label Beijing a currency manipulator — a public embarrassment China’s leaders hope to avoid.


Markets, for their part, started out optimistic although some early gains petered out.

European shares rose to a seven-week closing high while Asian currencies and stocks both rose and U.S. Treasuries fell on expectations that China’s move would ease political tensions with the West and encourage investors to snap up riskier assets.

“This can be viewed as a vote of confidence by the Chinese officials in the strength and the resilience of the Chinese economy and that is being taken as positive,” said Klaus Wiener, head of research at Generali Investments.

But U.S. investors saw early bravado give way to doubt, pushing the Dow Jones industrial average down 0.08 percent to 10,442.41, with the Standard & Poor’s 500 Index and Nasdaq Composite Index both seeing similar small declines.

Commodities markets also saw gains pared after sharp early jumps driven by hopes that a stronger yuan would fuel Chinese demand for everything from copper and oil to soybeans. Even gold, which hit record highs earlier in the session, ended lower on profit-taking [ID:nSGE65K00C]

Slideshow (4 Images)

Many economists see China’s currency strengthening further in coming days but at a very modest pace, further diluting hopes for big market gains.

A Reuters poll of 33 economists showed they expected the yuan to end the year at 6.67 per dollar, a rise of 2.4 percent from late last week before China’s policy announcement and similar to the appreciation implied by offshore non-deliverable forwards.

Additional reporting by Koh Gui Qing, Edmund Klamann, Karen Yeung, Saikat Chatterjee, Simon Rabinovitch, Wayne Cole, Pedro da Costa, Ben Blanchard, Brian Love and Sui-Lee Wee; writing by Andrew Quinn; editing by Simon Denyer and Todd Eastham

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