Friday July 22, 2005 - 10:07:32 GMT
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INVESTICA Ltd - www.investica.co.uk
China's next move crucial
The yen strengthened sharply after the Chinese central bank abandoned the yuan peg to the dollar and switch to a trade-weighted mechanism. The yen strengthened to just beyond 110.0 before staging a partial retreat to near 111.0 in early Europe on Friday. The yen also strengthened sharply against the Euro. Volatility is likely to remain high in the short term and initially there will also be pressure to cut short yen positions.
The Chinese yuan will be revalued immediately by 2.1% to 8.11 from 8.28 previously and the authorities will switch to a trade-weighted band. The yuan will be allowed to fluctuate in a narrow 0.3% band against the dollar with non-US dollar currencies allowed to fluctuate by 3% either side of the central rate. There is major uncertainty over the pace of future appreciation with the yuan kept in a narrow band for now and the future policy will be very important for the yen. If the Chinese currency is allowed to strengthen further, there is the potential for more sustained upward pressure on Asian currencies in general and the Japanese currency. In this environment, there would also be reduced demand for US securities which would lessen dollar demand. If the Chinese authorities resist further appreciation, there will be some speculation that short-term flows into Asia will drop and this could weaken the yen.
Overall there is still likely to be reduced Asian buying of US Treasuries which will tend to support regional currencies and lessen potential support for the US currency. This is likely to be an important medium-term factor in offering yen support.
Any Asian currency gains would lessen Japanese resistance to a stronger domestic currency, but there will be a high risk of intervention if markets become disorderly. The Finance Ministry has warned that it will take action to stabilise markets if necessary
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