China’s monetary policy direction suggests appreciation of RMB, says Stratton Street’s Andy Seaman

Andy Seaman, partner and portfolio manager at Stratton Street, says that a policy of monetary tightening in China points to an appreciation of the RMB against other currencies.

Zhou Xiaochuan, the governor of the Peoples’ Bank of China announced on Wednesday a major divergence in global monetary policy at the major news conference of the year. While the rest of the world is easing still, China is going to start tightening.

The move came after a slight uptick in inflation to 3.2% in February, a ten month high, although Chinese New Year may have affected this month. Last year inflation was 2.6%. He stated that “in the past some of us thought it was no big deal if inflation was a little bit high, growth will be a little faster and then we can control inflation afterwards. But international experience and our own experience here show that this thinking might not be correct. It requires careful attention to maintain low inflation.”

This is something that we have been expecting for a while, as there are many good reasons for China to raise rates. We like to compare the experience of China now with Japan in the 1970s; at that time as growth in Japan slowed from the 11% rates of the 1960s economic miracle to 5%. After the collapse of the Bretton Woods system, Japan sharply tightened monetary policy to control inflation, and ran a tight policy targeting M2. Inflation came down from 15% in 1976 to nothing ten years later, all without affecting the growth rate, in an example of textbook monetarism. During that period the yen appreciated sharply from the very undervalued level it had started off.

The PBoC is likely to follow a very similar course as Japan, and we are just seeing the beginning of this tightening, and the consequent currency appreciation, which will be combined with ongoing liberalisation of the renminbi. Zhou Xiaochuan was due to retire at 65 this year, after more than ten years as governor, but this week he was elected to the Chinese People’s Political Consultative Conference which means that he is now exempted from this retirement rule, which also means he will almost certainly be staying to continue the liberalisation and monetary agendas he has been building

 

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