Expectations that China will widen the renminbi-US dollar trading band in the near-term are growing as the nation seeks to use additional tools in its fight against persistently high inflation.

Currency strategists Callum Henderson and Robert Minikin of Standard Chartered Bank put the case forward only this week, while a government official at China’s State Administration of Foreign Exchange (Safe) has also spoken out in favour of greater flexibility in the RMB exchange rate.

StanChart expects the People’s Bank of China (PBoC), the central bank, to widen the RMB-dollar daily trading band from +/-0.5% to +/-1.0% within a matter of weeks.

This would come just a year after the RMB was depegged from the US dollar in mid-June 2010, but more than three years since the last move was made to widen the trading band from +/-0.3% in May 2008, note Henderson and Minikin.

Callum Henderson

Henderson tells AsianInvestor that widening the band would send a strong signal and would have two implications. “One, it would give China greater capacity to offset inflationary risks,” he says. “Second, as Chinese authorities are conscious of the fact that there is enormous interest in holding long RMB positions, this measure would enable China to introduce more two-way volatility into the RMB.”

Fighting inflation has been Beijing’s primary concern since last year. Despite four interest-rate hikes since October, the country’s CPI still stood at 5.3% in April. That is expected to accelerate to 5.5% in May, according to a median forecast of economists in a Bloomberg survey.

Against this backdrop of stubbornly high inflation, Will Oswald, StanChart’s head of fixed income, currencies and commodities research, says he fully expects Chinese authorities to increase the role that the currency rate plays in controlling inflation, leading to a widening of the daily RMB-dollar trading band. 

This would be consistent with policymakers’ gradual approach to foreign exchange and financial market reform, he adds, giving authorities a cushion against adverse economic movement. 

Earlier this week, Guan Tao, head of Safe’s balance of payments department, expressed the view that China should expand its capital outflow channels while gradually expanding the RMB-dollar trading band. 

“Enhancing flexibility is core to improve the RMB currency rate mechanism, which is to let the market play a more important role in exchange rate formation,” he wrote. “We do not need to fear exchange rate flotation as it is not equal to one-way appreciation of RMB; flotation is good for two-way volatility, which curbs one-way speculation.”

Further, Oswald adds: “It is better to introduce this [widening] measure now when the trade surplus is narrowing due to sluggish external demands instead of at a time when the global economy is booming, so that CNY will eventually no longer be a one-way bet as it seems be right now.”

That said, Standard Chartered sees the currency measure as just another instrument in the policy tool-kit, not one which would be used as a substitute for monetary measures such as interest rate hikes.

“The exchange rate can have an impact on inflation for China, but the impact is not going to be sufficient [on its own]," says Oswald. "Therefore, we haven’t changed our view of the rate profile in China and still expect to see one more rate hike from the PBoC this year.”

If the widening measure materialises, the bank expects the immediate impact to be increased interest in going long RMB, as well as increased intra-day volatility. Oswald also expects the measure to act as a catalyst for RMB liquidity to increase.

The bank recommends that investors short US dollar-RMB via one-year non-deliverable forwards, targeting appreciation up to 6.2 RMB per US dollar, with stop loss at 6.44 per US dollar.