May 16, 06

NEWS / Chinese juggling with yuan risks the wrath of Europe and Japan

CHINA allowed its currency to break through the watershed of eight yuan to the dollar to its highest in a decade yesterday, but left room for scant if any gains against the euro and the yen in a policy that could vex Europe and Japan.

The Chinese central bank, set yesterday??™s yuan central rate at 7.9982 against the dollar ??” the first time that it has gone past eight since the authorities revalued the yuan by 2.1 per cent last July.

The move to let the yuan rise to the key level came after a decision last week by Washington not to accuse Beijing formally of manipulating its currency. That will have enabled Beijing to feel greater freedom to allow the yuan to climb without seeming to bow to US pressure.

Economists now expect China to allow the currency to appreciate at a faster pace.

The yuan has risen by about 1.4 per cent against the dollar since last July, but, in a trend which could trigger a backlash against Beijing from Europe or Japan, the yuan has weakened sharply against both the euro and the yen since late last year.

The yuan??™s continuing slide against its European and Japanese rivals adds to China??™s already huge competitive advantage in those economies. It also adds to economic stress on the eurozone and Japan from the dollar??™s slide, forcing the euro and yen to bear more of the burden of adjustment.

With the yuan??™s losses against the euro and yen mirroring those by the dollar, at 9 per cent and 7 per cent respectively over the past six months, the trends underline the theoretical nature of China??™s supposedly new exchange rate link to a currency basket. In practice, the yuan remains effectively pegged to the dollar.

One reason for this strategy by Beijing is the intensity of US pressure. Europe and Japan have traditionally adopted more subtle means. But economists sounded warnings that this tolerance might not last indefinitely if a weakening dollar continues to take the yuan lower, adding to the trade disadvantages for Europe and Japan.

???Eventually, someone in Brussels or Tokyo is going to notice this and China??™s currency valuation will become politicised in other parts of the world,??? Carl Weinberg, of High Frequency Economics in New York, said.

Other analysts disagree. Yesterday there was little sign of immediate tensions emerging as Charlie McCreevy, the European Internal Market and Services Commissioner, and Jin Renqing, the Chinese Finance Minister, ended a day of talks with a joint statement that only emphasised China??™s commitment to press ahead with reform of its currency regime.