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Yuan only live twice – or so it seems

March 31, 2014

The yuan’s decline against the dollar to its lowest level in 13 months has come after China’s central bank said it would widen the band in which the currency trades every day as it seeks to allow it to trade more freely. Great news for anyone seeking to buy Chinese imports, especially in Europe, as the offshore yuan (CNH) is at its lowest in over two years against the euro. Or is it? Neal Kimberley, Reuters FX analyst and a weekly guest in the forum, says right now it’s something of a double source of pain, not least because of the exposure euro zone exporters have to the Chinese currency now. “Much euro zone selling into China has now moved away from dollar invoicing to yuan (ie CNH). Invoicing EUR/CNH is a HUGE book now,” Neal said earlier. “The euro zone authorities will be very conscious that a combination of two-way risk on the yuan and a resurgent programme of urbanisation in China are a possible disinflationary impulse for the outside world generally and for the euro zone in particular.”

This can hardly be music to the ears of European Central Bank policymakers who meet this week to set interest rates and wrestle to respond to euro zone inflation sliding deeper in the so-called “danger zone” below 1 percent. An initial estimate showed prices rose just 0.5 percent year-on-year in March, the least since late 2009 and well below the ECB’s stated target of around or just below two percent. And a strong currency is the last thing the euro zone’s corporate world would welcome right now. The euro is already trading around $1.38, having touched its highest in over two years this month against the greenback, and around its highest against the yen since the 2008 crisis. “Euro zone treasurers will be waking up in a cold sweat above $1.40 and above $1.45 – and here’s the thing – if (the euro) is $1.3950 bid or JPY144.50 bid, do you hedge on the assumption it is going through (those levels) or do you do nothing?,” Neal asks. “If the latter, you’d better have a good explanation for the ‘hindsight-management’ who will pillory you if it does go and you were under hedged. So most will hedge, thereby making their nightmare scenario self-fulfilling.”

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