China set to ease further, CNY to weaken gradually over next 12 months

This week, China's premier gave a pretty clear hint that more stimulus will be coming. According to the Chinese media, he had assured Chinese businesses at a forum that more would be done to lift growth and mentioned financing as part of this. It clearly suggests that China will cut interest rates further. The debt burden in Chinese companies is a concern and, by cutting interest rates, the People's Bank of China would ease this burden. Inflation is low at 1.3% y/y and hence there is plenty of room on the inflation front to ease further. In Q3, nominal GDP growth at 6.2% y/y was the lowest in 15 years and, even though signs of the cycle turning, it is believed the government is likely to aim to do more to ease the current burden on businesses. Cutting interest rates is one tool that can be used to do this.

With China easing further and the Fed about to raise rates, the CNY has seen more depreciation pressure lately. As the currency has become more market based, relative rates have started to matter more. Economists look for a weaker CNY over the next 6-12 months but do not expect a sharp weakening of the CNY within a short time. China is about to be approved for inclusion in the SDR and does not wish to rock the boat now. Many market participants expect China to let the CNY weaken substantially once it has been included in the SDR.

"We believe China will continue to intervene to avoid a too sharp move. If it weakens too much, it could spur fears of a big devaluation and lead to renewed capital outflows. China has no interest in this, as it would also hurt the economy. Hence, we look for only a gradual depreciation by around 4-5% over 12 months", says Danske Bank.