CNY to gradually weaken against USD as China loosens policy further and US Fed raises rates

Weak external demand and sharp slowdown in construction sector has impacted China’s activity. In the fourth quarter of 2015, the economy slowed to 6.8% y/y due to weakness in construction and industry sector. The service sector expanded strongly more than 10%. Meanwhile, private consumption expanded at a modest rate of about 8% y/y.

According to Danske Bank, there are tentative signs of a slow rebound in construction sector as stimulus measures have increased home sales and oversupply of housing is slowly easing. Fiscal stimulus has supported investment in infrastructure, while service sector and consumption growth are likely to remain strong, says Danske Bank.

“The Chinese government’s growth target for 2016 is 6½-7%. Our forecast for GDP growth is 6.7% and 6.6% for 2016 and 2017”, says Dansk Bank.

Sharp rise in debt in the past few years are posing as major challenges for China. There is an increase in non-performing loans. The country requires slowing the build-up of debt. The increase in non-performing loans should stabilze as construction rebounds, says Danske Bank. China has a current account surplus of 3% of GDP. Meanwhile, the central bank has an easing bias.

“We look for a further decline of the RRR of 50- 100bp this year and additional rate cuts of 50bp over the next six months. The lower interest rates will give further stimulus to housing and ease the burden on companies”, says Danske Bank.

Meanwhile, China was able to stabilise outflows by raising offshore money market rates through intervention. Markets have calmed down since then. China is unlikely to devalue as the markets have feared.

“We expect a continued gradual weakening versus the USD as China eases further and the Fed raises rates. We look for a gradual weakening towards 6.85 +12M versus the USD, a depreciation of around 5%”, says Dansk Bank.