China's currency rose to a new record against the greenback on Thursday after the Federal Reserve of the United States cut a key interest rate by 25 basis points a day before.

 

Before Thursday's trading started, the People's Bank of China, the central bank, set the yuan central parity rate at 7.4552 relative to the US dollar. The new midpoint marked an appreciation of 0.6 percent in the past seven trading days and a 4.6 percent rise since the beginning of the year.

 

Now that the US Fed has reduced its rates in order to prevent a sudden slowdown of the world's largest economy, making the greenback less valuable in the eyes of investors, analysts predict that China's yuan, in tandem with other world major currencies, will face rising pressure to appreciate on the market.

 

The hefty rise of 140 basic points of the yuan vs the US dollar overnight, came after the Fed slashed the federal funds rate, an overnight lending rate between banks, by 0.25 percentage points at the end of a two-day meeting on Wednesday, promoting investors to seek higher-yielding assets elsewhere.

 

"The rate cut further reduces the appeal of dollars and will facilitate the capital flow to emerging markets, including China," Professor Guo Tianyong of the Central University of Finance and Economics (CUFE) told chinadaily.com.cn Thursday morning.

 

However, China's exchange rate formation system is still a managed floating regime, Guo said, adding that the central bank had to take various factors into consideration when deciding whether to allow a faster appreciation in the coming days.

 

In addition to the exchange rate pressure, China faces another fallout from the Fed move. Before the US rate reduction, there was wild speculation in China that the central bank, headed by Zhou Xiaochuan, was mulling the sixth interest rate hike this year to keep the world's fastest growing economy from overheating.

 

China now faces increasing inflationary pressure. The country's gross domestic product grew 11.5 percent year-on-year in the third quarter, while inflation jumped 6.2 percent in September, the National Bureau of Statistics said last week.

 

"However, the Fed move increases the difficulty for the central bank (to curb inflation)," said Professor Song Guoqing of Peking University. Song said that he still anticipated an interest rate rise this year.

 

Guo Tianyong of CUFE shared his observations, saying the pressure on the central bank is growing. But Guo deemed that the central bank has the room to raise rates as there remains a difference between benchmark interest rates in China and the United States.

 

The current one-year deposit rate in China stands at 3.87 percent while the US federal funds rate is 4.50 percent after Wednesday's cut.

 

Moreover, the interest spread is not the major concern for the central bank, Guo said, adding that domestic inflationary level and asset prices are more important factors to decide changes.

 

(Chinadaily.com.cn November 1, 2007)