Dollar Weakens as End to Yuan Peg Signals Confidence in Global Recovery

By Keith Jenkins and Yasuhiko Seki - Jun 21, 2010

The dollar declined to a four-week low against the euro after China signaled an end to the yuan’s fixed rate to the greenback, boosting confidence in the global economic recovery.

The Australian and New Zealand currencies advanced to one- month highs after China said it may let the yuan strengthen, boosting demand for nations that sell products to the world’s third-largest economy. The People’s Bank of China two days ago indicated it’s abandoning the 6.83 yuan peg to the dollar adopted to protect exporters during the global financial crisis.

“The dollar has weakened across the board as the market takes the Chinese announcement as a supportive development for global growth,” said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “It’s an indication that they’re more confident in the recovery in both China and in the global economy. Other commodity currencies, such as the Australian and New Zealand dollars, benefit from the boost in risk sentiment,” he said.

The dollar fell to $1.2460 per euro at 7:43 a.m. in London from $1.2388 last week in New York, after reaching $1.2487, the weakest level since May 24. Australia’s dollar rose 1.4 percent to 88.40 U.S. cents, after touching 88.43 cents, the most since May 17. New Zealand’s dollar climbed 0.9 percent to 71.29 cents after touching 71.40 cents, the strongest since May 14. The yen was at 90.80 per dollar from 90.71.
The Chinese central bank made its announcement at 7 p.m. Beijing time on June 19 in a posting on its website, a week before leaders from the Group of 20 meet in Toronto.

U.S. President Barack Obama, in a statement, called China’s decision a “constructive step.” Lawmakers in the world’s largest economy said China’s move was insufficient.

PBOC Announcement 

The PBOC said in a follow-up statement a more flexible currency will “direct resources to domestic-demand driven sectors such as services” and help curb an excessive reliance on exports, signaling it anticipates the currency will rise.

Authorities will resume a managed float of the yuan against a basket of currencies, according to the June 19 statement. Before the exchange rate was frozen in July 2008, Premier Wen Jiabao’s government had allowed a 21 percent advance versus the dollar over three years.

Analysts at banks from Goldman Sachs Group Inc. to Royal Bank of Scotland Group Plc predicted gains in the yuan in the coming year will be held to less than 6 percent. The median of 14 forecasts in a Bloomberg News survey indicates an advance to 6.7 by Dec. 31.

‘React Positively’ 

“Financial markets are likely to react positively to China’s decision to de-peg from the dollar,” said Gareth Berry, a currency strategist in Singapore at UBS AG, the world’s second-largest foreign-exchange trader. “The currencies of those economies with the largest share of exports to China, which are Australia, Japan, Taiwan, Korea, Brazil and Indonesia, will likely rally.”

Other currencies that do well when investors become more willing to take risks, such as the Canadian and New Zealand dollars, Nordic currencies and those from emerging markets, will also likely benefit, according to Berry.

China’s central bank yesterday reaffirmed it would maintain the yuan’s 0.5 percent daily trading band and said greater flexibility would help cut the trade surplus and reduce the reliance on exports as a driver of growth.

Aussie, Kiwi 

“The decision by China will strengthen the purchasing power of its government and Chinese companies,” said Daisaku Ueno, president at Gaitame.Com Research Institute Ltd., a unit of Japan’s largest currency margin company. “Thus the move will support resource-exporting countries such as Australia.”

The yuan has been held at about 6.83 to the dollar since mid-2008. Its peg was scrapped in July 2005 and replaced by a managed float against a basket of currencies including the euro and the yen. The yuan rose 0.36 percent to 6.802 per dollar today, the sharpest gain in 20 months, according to China Foreign Exchange Trade System.

Stocks rallied as renewed risk sentiment damped demand for the relative safety of the greenback. The MSCI World Index of shares advanced 0.6 percent, extending its run of gains to ten days.
“China’s move is likely to be positive for risk taking,” said Hideki Amikura, deputy general manager of foreign exchange in Tokyo at Nomura Trust & Banking Co., a unit of Japan’s largest brokerage. “This should lead to appreciation in Asian currencies.”

Futures traders decreased their bets to the least in two months that the euro will decline against the U.S. dollar, figures from the Washington-based Commodity Futures Trading Commission showed.
The difference in the number of wagers by hedge funds and other large speculators on a decline in the euro compared with those on a gain -- so-called net shorts -- was 62,360 on June 15, the narrowest since April 16, and compared with net shorts of 111,945 a week earlier.

To contact the reporter on this story: Keith Jenkins in London at kjenkins3@bloomberg.net; Yasuhiko Seki in Tokyo at yseki5@bloomberg.net.