Daily 1 percent limit appropriate, Bank of China analyst says

BEIJING - The yuan's daily trading band against dollar will probably soon be widened from the current 0.5 percent to 1 percent, said a report released by Bank of China Ltd (BOC) on Thursday.

Cao Yuanzheng, chief economist of the bank, said since the government allowed the currency to resume appreciation last year, strong expectations and the narrow band have led to a continuous increase in the yuan's exchange rate.

"A wider trading range will help to form a market-based exchange rate, as it requires more market hedge behavior and allows the rate not only to rise, but also to fall," Cao said, adding that a daily limit of 1 percent is more appropriate and in line with international conventions.

The People's Bank of China (PBOC), the central bank is hesitant about widening the band, mainly because of concerns about rising capital inflows, fearing that will add to excessive liquidity and counter the effectiveness of the monetary measures it has taken, including raising interest rates, he said.

To keep the exchange rate stable, the PBOC has set a daily reference rate for the yuan and it is allowed only to fluctuate to the daily limit on either side of the reference rate. The trading range was widened to 0.5 percent from 0.3 percent in May 2007.

In June 2010, the central bank decided to resume yuan appreciation after a two-year peg. The exchange rate has increased by about 5.5 percent against the dollar since then.

Cao predicted it will appreciate by more than 6 percent through the whole year against the dollar.

"Support for more daily volatility of the exchange rate has always been there. However, the most urgent task is not to widen the daily trading band, but to promote trade balance and ease pressure of hot money inflows," said Zhao Qingming, senior researcher at China Construction Bank Corp.

Standard Chartered Plc said earlier that the widening of the band may happen "in the coming months" as the government takes measures to curb inflation, said Callum Henderson, global head of currency research at Standard Chartered in Singapore, in an interview with Bloomberg.

China's consumer price index (CPI), a main gauge of inflation, rose 5.5 percent year-on-year in May. That's the highest level since July 2008.

In the first five months of this year, the index rose by 5.2 percent year-on-year, 1.2 percentage points higher than the ceiling set by the government.

Agricultural Bank of China Ltd said in a report published on Wednesday that the index is likely to peak at 6.4 percent in July before slowing down in the following months.

To curb inflation and maintain steady economic growth, the central bank is likely to raise deposit interest rates another one or two times in the third quarter, while leaving lending interest rates unchanged, BOC said.

It predicted the world's second-largest economy will secure a GDP growth rate of 9.3 percent, and CPI will be confined around 5 percent.

China Daily

(China Daily 07/01/2011 page14)