Officials at the People’s Bank of China should be feeling pretty pleased with themselves. Market expectations for future renminbi appreciation have tumbled following a month of slower currency gains and acknowledgement from the leadership that inflation risks have fallen. The non-deliverable forwards market is pointing to gains of only 3.4% against the dollar over the next 12 months, the lowest since late 2006 and down from 11.5% in March. The result is that the speculative pressures that have been driving a potentially destabilising wave of capital into China have eased. We think this shift in expectations is hard to justify. The economy is still in good shape, with consumption spending and export growth both much stronger than almost anyone expected a few months ago. Meanwhile, pipeline price pressures still linger. More fundamentally though, the arguments in favour of appreciation pre-date recent concerns over inflation. Simply put, China cannot rebalance its economy with a severely undervalued currency. We expect rapid renminbi appreciation to continue.
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