Page last updated at 10:19 GMT, Thursday, 8 April 2010 11:19 UK

When will China change yuan policy?

By Simon Derrick
Senior currency strategist, BNY Mellon

Over the past eight years, the issue of what China is doing with its currency, the renminbi or yuan, has been a constant topic of discussion among both politicians and investors.

Hundred-dollar bills and 100-yuan notes
The dollar-yuan exchange rate is a sensitive issue for the US and China

The reason for why this has been such an important issue is simple enough: since the start of 2002, China has sold an astonishing $2.187tn worth of its own currency, in an attempt to stop it gaining in value.

While a wide range of reasons have been given for this, only one really matters: to ensure that China's industries have remained competitive against those of the rest of the world (including those in the UK).

There have been some signs, however, that all this may be about to change.

On Thursday of last week, it appears that there was an extended telephone conversation between President Hu of China and President Obama.

During the call, they are said to have agreed that their countries should "respect each other's core interests and major concerns, appropriately handling disputes and sensitive issues, strengthening communication and co-operation in various spheres".

Given subsequent comments from both Chinese and US officials, it appears that one of the "sensitive issues" to be addressed is China's currency policy.

What, then, are the Chinese likely to do and, as importantly, when are they likely to move?

Freer range?

One possible initial policy change that China might be considering is to allow its currency to move a little more freely against the US dollar on a day-to-day basis.

Indeed, one prominent academic in China has indicated that this daily range could be as wide as 3%.

Although this might only appear a modest shift, it is worth remembering that the US dollar has also been increasing in value against a range of currencies since the start of this year, including sterling.

If China is to allow its currency to move a little more freely, then July might prove the perfect month to do so

Indeed, were China to allow its currency to rise by 3% against the dollar today, it would mean that its currency would have risen by more than 9% overall against the pound.
This would provide a significant boost for UK manufacturers that compete directly against firms based in China.

While the question of what China might do with its currency seems easy enough to answer, the issue of when the move could occur remains harder to work out.

Nevertheless, some clues have emerged from both the US and China over the past week.

In particular, the head of the US Treasury, Timothy Geithner, noted over the weekend that there are a number of key international meetings taking place in the coming months where there could be "material progress" on China's exchange rate.

These include a gathering of the finance ministers and central bank governors of the G20 group of nations later this month in Washington, as well as talks between the US and China (known as the Strategic and Economic Dialogue) scheduled for late May.

'Perfecting' policy

This would suggest that China could make an initial move on its currency by the summer of this year.

Interestingly, an influential Chinese financial magazine has argued that the move could come rather sooner than this.

In an article published last week, it indicated that the plan could be put into action at some point this month.

Perhaps tellingly, the paper argued that now was seen by officials as a key time for "perfecting" currency policy, given that it is almost five years since China first attempted to reform its foreign exchange markets.

Despite this, our own view remains that if China is to allow its currency to move a little more freely, then July might prove the perfect month to do so, given that it represents the anniversary of previous moves in 2005 and 2008, as well as being a month largely free of major political meetings.

However, although this argument makes sense, the flow of news over the past few days opens up at least the possibility that China could move at any point over the next few months.

With the head of the US Treasury visiting China, it may be worth keeping an eye open for some surprise announcements.

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