The renminbi has depreciated by about 8% against the US-dollar so far this year and at RMB6.96 per US dollar is already homing in on our year-end target of RMB7 per US dollar.
China’s central bank, the People’s Bank of China (PBoC), has begun to resist further depreciation, cutting its reserve requirement by 2 percentage points to 6% last week and also setting the daily fix for the official exchange rate at stronger-than-expected rates in recent days. But with the US dollar still surging, and probable recessions in most developed markets set to weigh heavily on external demand, there is a clear risk that the exchange will overshoot to somewhere in the region of RMB 7.10-7.20 per US dollar.
A weaker renminbi is often associated with delivering a deflationary impulse to the rest of the world. After all, as the currency depreciates, imports of Chinese goods become cheaper for the rest of the world. So has the recent depreciation of the renminbi relieved pressure on global central banks in their quest to tame inflation?
There certainly does appear to be a link between movements in the renminbi and rates of inflation experienced by its trading partners. For example, as the charts below show, US import prices from China fluctuate with the exchange rate. And these import prices are closely correlated with core goods inflation in the US. This makes intuitive sense, and similar relationships are observed in other economies such as the eurozone.
However, there are a couple of reasons to doubt that renminbi depreciation has solved the global inflation crisis.
For a start, the correlation between movements in the currency and prices really only applies to the core goods portion of inflation in other countries.
The renminbi has no major impact on other key drivers such as owners equivalent rent, local services or indeed international commodity prices; all of which account for the bulk of inflation in markets such as the US.
As such, the relationship between the renminbi and headline inflation, in this instance in the US, is quite weak with several periods of currency volatility failing to follow through into headline inflation.
More generally, we need to be careful about assuming that correlation means causation. After all, the renminbi tends to be very cyclical. When exports are growing strongly the currency tends to appreciate, and when exports are coming off – as is the case now – the currency tends to depreciate. And of course, when global demand is strong and China’s exports are performing well and the renminbi is appreciating, firms are more able to pass on higher costs to consumers and fuel inflation.
On this basis, global inflation dynamics are still really a function of the strength of demand and movements in the renminbi are largely a by-product of its impact on trade. Indeed, an expected slowdown in exports as demand for manufactured goods softened has been a key reason for our bearish view on the renminbi since the beginning of the year.
The upshot is that, barring an unlikely large one-off depreciation, the weaker renminbi neither significantly changes global inflation dynamics, nor the need for developed market central banks to keep on raising interest rates.