Chinese Yuan: Does the policy-rate tweak leave the appreciation outlook unchanged? – Commerzbank

With the lower rate already priced into bond yields and markets, Commerzbank continues to expect the CNY to appreciate gradually, supported more by PBoC guidance than by interest-rate differentials. Commerzbank’s Volkmar Baur says the PBoC will move its operational policy rate from the 7-day reverse repo to the overnight reverse repo, bringing it into line with actual money-market usage and the previously signalled testing at 1.25%.

Why does the operational shift leave the FX outlook unchanged?

"The People’s Bank of China (PBoC) announced yesterday that it intends to make a slight adjustment to the operational implementation of its monetary policy. At present, the central bank uses the 7-day reverse repo rate as its policy rate to steer the 7-day repo rate between deposit-taking institutions in the money market. The PBoC has now announced that it will switch to the overnight reverse repo rate as its policy rate, with the overnight interbank repo rate becoming its new money-market target."

"This may sound rather technical, but for the exchange rate the key point is simple: in essence, nothing really changes. Admittedly, the PBoC’s 7-day reverse repo rate currently stands at 1.4%, while the overnight rate is set to be 1.25%, which at first glance looks like a rate cut. However, markets had already anticipated this development."

"Trading volumes tell a similar story. Deposit-taking institutions have in any case been using the overnight repo market much more heavily than the 7-day market for years. Over the past five years, average daily volumes in the overnight repo market have been around 30 times higher than in the 7-day repo market."

"Bond markets had also anticipated a lower policy rate for some time. Yields on 2-year Chinese government bonds have been hovering around 1.25% since the end of April, while even 3-year government bond yields have been only slightly higher since June."

"Aside from the fact that the CNY exchange rate tends to respond more strongly to the PBoC’s guidance than to interest-rate differentials anyway, the change in the policy framework should therefore do little to alter our expectation of a continued gradual appreciation of the CNY."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)