Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options. HOMEPAGE

Everyone's watching the wrong central bank in the wake of China's shock devaluation

Since the People's Bank of China started cutting the yuan's value against the dollar earlier this week, people have been preoccupied with how that may affect the Federal Reserve's coming decisions.

Advertisement

But the Fed is probably not the major central bank that will pay most attention to moves in the Chinese currency.

There's a good reason to think the change in the PBoC's approach will have a bigger effect on Japan's monetary decisions than on those of the US, a point that can be summed up pretty well by this graph from analysts at Citi:

Citi trade weighted china currencies
Citi

The Chinese yuan makes up closer to 30% of Japan's trade-weighted index (TWI), compared with more like 20% for the US and less than 10% for much of Europe. The TWI measures a currency against basket of others, based on how much that country trades with another. So Japan's high exposure to China means the yuan is a larger portion of Japan's TWI basket.

In short, changes in the yuan have a considerably bigger impact on the yen than the dollar or the euro. Japan's economic policymakers want a relatively weak yen, and a weaker yuan makes that harder.

Advertisement
Japanese Economy Minister Akira Amari (L) and US Trade Rep. Michael Fromam participate in a press conference in Lahaina, Maui, Hawaii July 31, 2015.  REUTERS/Marco Garcia
A news conference in Lahaina, Maui, Hawaii. Thomson Reuters

According to Bloomberg, Koichi Hamada, influential economic adviser to Japanese Prime Minister Shinzo Abe, said "the magnitude of China’s shock is much larger than that from Greece, but we need not worry because always the effect of Chinese devaluation can be offset," hinting that further easing from the Bank of Japan would be appropriate.

Here's another snippet from Bloomberg's report:

"It's becoming hard not to expect additional easing," said Masamichi Adachi, an economist at JPMorgan Chase & Co. and a former BOJ official. "China's weakness is certainly bad news for Japan."

The yuan's devaluation will tend to put upward pressure on the yen, cutting import costs and making it harder for consumer prices to rise, Adachi said.

Advertisement

Twenty-one of 37 economists in a Bloomberg survey last month forecast the BOJ will eventually add to its record stimulus, with 12 predicting action in October.

The Bank of Japan has already engaged in massive monetary easing.

Though the Swiss National Bank has a larger balance sheet as a proportion of the country's gross domestic product (because of its huge purchases of euros in recent years), the BoJ stands out even against the Federal Reserve, European Central Bank, and Bank of England.

Here's how that looks:

Advertisement
central bank balance sheets
BAML

An Oxford Economics research note argued that the yuan's fall is yet another reason to expect a larger quantitative-easing programme from the Bank of Japan:

China's policy moves have made a further boost to the Bank of Japan's QE programme more likely as this would almost certainly trigger a further fall in the yen. Our call is for the annual rate of asset purchases to be increased to ¥100trn from the current ¥80trn in October. We see the yen at ¥130/$1 by early 2016 — from ¥125 today.

Analysts haven't all taken that view about the Bank of Japan, but there's no dispute that the decisions made about the yuan have a bigger impact on Tokyo than they do on Washington.

Yuan
Advertisement
Close icon Two crossed lines that form an 'X'. It indicates a way to close an interaction, or dismiss a notification.

Jump to

  1. Main content
  2. Search
  3. Account