No Sustained Depreciation For China’s RMB

China’s better economic data and international diplomacy are behind the Chinese central bank’s move to lower its currency’s exchange rate fixings, says BofA Merrill Lynch Global Research in a report.

The People’s Bank of China lowered its U.S. dollar to RMB fixing by 257 pips (one pip is equal to 1/100th of 1%) over June 6 to 10, before raising it again by 55 pips on June 11. This is basically the first major downside surprise to the exchange rate since the RMB’s trading band widening in March.

The lower exchange rate are consistent with some stabilization in macro data such as the March trade balance, which came in at US$35.9 billion versus an expectation of US$22.6 billion. The May HSBC and official PMI data were also better than expected, while China’s inflation data also bounced higher, allaying concerns over deflation risks.

Additionally, recent policy actions show China’s leadership stepping in to support growth. The PBoC is injecting liquidity via targeted commercial bank reserve requirement ratio (RRR) cuts and re-lending, diminishing to inject liquidity through unsterilized U.S. dollar buying intervention as was the case some months ago, says BofA Merrill.

On the bilateral front, the U.S. state department has confirmed that that the U.S.-China Strategic and Economic Dialogue (SED) will be held in Beijing in early July. This is also likely weighing on the setting of the RMB’s fixing in order to deflect the criticism of China being a currency manipulator.

The American bank believes the scope for sharp RMB appreciation is limited for the near term, as China’s policy makers continue to emphasize the need for two-way exchange rate movement. But BofA Merrill thinks that sustained RMB depreciation is unlikely to be China’s preferred way to stimulate the economy, given its current objective of economic re-balancing from exports to domestic demand.

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