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China relaxes currency peg

China has made moves to allow more flexibility for the value of the yuan in its trade against the U.S. dollar.

Story highlights

  • China expanded the daily trading range that its currency can fluctuate against the US dollar
  • Move is an important step towards allowing the yuan to eventually float freely

China expanded the daily trading range that its currency can fluctuate against the US dollar on Saturday in an important step towards allowing the Rmb to eventually float freely.

The People's Bank of China, the country's central bank, announced that starting on Monday the Rmb would be allowed to rise or fall each day by as much as 1 per cent from the daily official rate against the US dollar, a doubling of the trading band from the previous 0.5 per cent limit.

The trading band limits how much the currency can rise and fall from an official rate set each day by the central bank and announced before the foreign exchange market opens each day.

The trading band was last widened in May 2007 from a daily limit of 0.3 per cent appreciation or depreciation from the official daily rate to 0.5 per cent per day.

Unlike at that time, the latest widening of the band is not seen as a sign that China will allow faster appreciation of its currency in the coming months.

Instead it is likely to signal greater volatility in the Rmb's value against the dollar as the central bank allows the market to play more of a role in daily movements.

Chinese officials have talked increasingly in recent months about the need for more flexibility in the exchange rate and the importance of eventually making the currency fully convertible.

Pressure on China's currency to appreciate has diminished since last year as the country's trade surplus and capital inflows have shrunk and an increasing number of officials and experts argue that the Rmb is approaching its equilibrium level against the dollar.

Christine Lagarde, Managing Director of the International Monetary Fund welcomed Saturday's move. "This underlines China's commitment to rebalance its economy toward domestic consumption and allow market forces to play a greater role in determining the level of the exchange rate,@ she said/

HSBC said the move was: "Symbolic in recognising the increased fundamental two-way volatility of flows (as a change from the past where appreciation pressure was persistent and large), and as a signal that the [exchange rate] regime is evolving to become more flexible in-line with these changes."

The Rmb has only hit the daily 0.5 per cent limit on a few occasions since 2007 and most of those occasions occurred at the end of last year when for the first time the Rmb showed sustained weakness and its value fell by the daily limit against the dollar.

Since China unpegged its currency from the dollar in 2005 the Rmb has gradually appreciated by just over 30 per cent against the dollar despite the reintroduction of a de facto peg during the height of the financial crisis from 2008 until mid-2010.

The daily trading band limits intraday fluctuations but the central bank theoretically has no constraints on how it sets the daily official exchange rate and so still has the ultimate say on whether the Rmb appreciates or not.

On top of that, the central bank is an active participant in the foreign exchange market, a key reason why China has accumulated by far the world's largest foreign exchange reserves, which now amount to about $3.2tn.