China Pumps Up Its Currency, But To What End?

China’s most recent manufacturing data showed recovery spluttering with exports soft, yet the yuan follows that by hitting a 19-year high agains the dollar. More intriguingly, the People’s Bank of China has let the currency rise within the allowable limits of its daily trading band; the yuan can rise or fall by 1% from a daily reference rate fixed in the morning by the central bank.

The yuan certainly isn’t off the leash, but the central bank is giving it more latitude of late than it has in the past. The currency has gained five times as as much so far this year as it did in all 2012. The question is whether this is part of the central bank’s preparations to open further China’s capital account, a next step being to widen the daily trading band of the currency. Those of that view latch onto the words of PBoC deputy governor Yi Gang who told last month’s annual meeting of the International Monetary Fund in Washington that the band would be widened “in the near future.” The previous revision was announced in April last year, when the band was doubled.

Another doubling might  be on the cards. If it is, it would most likely be to get the currency swiftly to an equilibrium level with the dollar as much as anything. The aim would be to discourage the present one-way bet on appreciation that currency speculators now regard the yuan to be. Policy makers are exasperated by that. They  consider the yuan to be close to where it should be against the dollar (real trade weighted value might be another thing, though). Except in exceptional circumstances most freely convertible currencies aren’t so volatile on a daily basis that they bounce around in a 4% range, so there doesn’t seem much need to widen the band just to accomodate regular daily trading fluctuations.