INTERNATIONAL BANKING AND FINANCE

International Banking And Finance

International Banking And Finance

USD, EUR and JPY: further dollar appreciation

Given our expectation of gradual appreciation, we do not foresee a large near- term impact on the value of the USD, EUR and JPY. Our long-standing view on the main crosses has been that the dollar would at some point regain its strength against the EUR and JPY, not because of strong US fundamentals, but rather because of our pessimistic assessment of the European economies. We view recent movements in these currencies as the start of this phase. We expect the evolution of these currencies in 2010 and 2011 to be determined by three factors: 1) relative growth prospects, where we foresee a more positive forecast for the US; 2) monetary policy developments, where we think the ECB and the BoE are “trapped” in their QE policies whereas the US has a clearer exit path; and 3) sustainability of public finances. We admit that we have more doubts in the latter dimension, as the US fiscal position is a clear source of concern as well. However, the problems in Europe are more immediate, as the movements triggered by the Greek crisis and the possibility of a stalemate in UK politics demonstrate. Moreover, we think markets may be underestimating the role of the ECB and the BoE in sustaining public finances. The US has more time to fix its fiscal position. How would a more rapid RMB appreciation than in our baseline affect these factors? On growth, the effect is likely to be small but biased towards the US. In isolation, the impact of RMB appreciation in effective exchange rates is the most (see Table 2). This would be particularly true if our forecasts for further Asian currencies are fulfilled (see below). Given low export elasticities, the overall impact on growth would be very small, as corresponds with our view that the net effect of a modest appreciation on Chinese imports would be limited. Accordingly, the relevance for their respective monetary policies is not an issue. The main effect would be in the financing of US deficits. Following the experience of 2005 and after recent comments by Chinese officials, once the RMB begins to move, expectations of even faster renminbi appreciation would be likely to gain traction among investors, fostering an increase in speculative capital flows to China and a corresponding acceleration in the near term of the pace of reserve accumulation .

Impact on other Asian Currencies

In our baseline, we expect most Asian currencies to appreciate over the next 1- 2 years. This is because of the following inter-related factors: (i) the region is expected to grow (much) faster than its trading partners outside the region; (ii) monetary policy will be tightened faster than in the US and Europe; (iii) most economies are running large current account surpluses; and (iv) the outlook for capital inflows is positive. All else equal, faster RMB appreciation relative to baseline should accelerate these ...