Chinese Yuan may mimic rate differentials

While interest rate differentials have been closely linked to relative values of the USD, Euro, and Japanese Yen, most people never figured the hot topic would ever be applied to the Chinese Yuan. After all, few international investors seriously care about interest rates in China, right? One economist, however, has established a strong relationship between the China-US interest rate differential and the value of the Chinese Yuan. Specifically, he figures that the Yuan’s annual appreciation will equal or come close to equaling the difference in American and Chinese interest rate levels. His reasoning is that those who invest in Chinese assets require a return equal to the yield on comparable US investments. Since American interest rates are currently 3.3% above Chinese interest rates, he theorizes that the Yuan will appreciate 3.3% this year to make up the difference. The Wall Street Journal reports:

The bottom line is that China’s Central Bank must carefully watch inflation and interest rates in the U.S. when formulating its own exchange-rate-based monetary policy.

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