Yuan's Fate Hangs in Balance as August CPI Data Looms

The offshore Chinese currency (CNH) is holding steady on Tuesday, with the USD/CNH pair trading at 7.1134, a marginal decline of less than 0.1% for the session. Market attention is firmly fixed on China’s upcoming inflation figures for August, set to be released early Wednesday (01:30 GMT).

Analysts anticipate China’s Consumer Price Index (CPI), a crucial inflation gauge, to show a 0.2% year-on-year decrease for August, compared to July’s flat reading. This potential dip could reignite worries about the strength of Chinese domestic demand.

Currency traders are eyeing this report as a litmus test for Beijing’s economic policies. The People’s Bank of China (PBoC) set its reference USD/CNY rate at 7.1008 today, slightly below the previous day’s level, hinting at efforts to stem the currency’s depreciation.

This fresh economic indicator will play a pivotal role in shaping monetary expectations and evaluating the government’s capacity to effectively combat deflationary pressures.

USD/CNH Technical Outlook: Downward Trajectory Persists

The USD/CNH pair has maintained a clear downward trend since the year’s beginning, despite a brief uptick that saw the pair approach the April 8 peak of 7.4291.

Having recently touched a new low since November 6, 2024, at 7.1133, the pair now faces a critical support zone around 7.1000. This level has previously acted as a floor and coincides with the daily downtrend line.

A decisive break below this zone could propel USD/CNH towards the September 2024 low of 6.9713.

Should the 7.1000 support hold, the currency pair might rally towards the 100-day simple moving average, currently situated at 7.1873.

Economic Resilience Tested as Inflation Concerns Linger

The Chinese economy has demonstrated resilience in the first half of the year, posting GDP growth of 5.3%, bolstered by rebounding consumption and exports to markets beyond the United States.

However, as Christine Peltier from BNP Paribas notes, “the fight against deflation is far from over.”

July’s slowdown in industrial activity (5.7% year-on-year vs. 6.6% in H1) and the contraction in manufacturing investment (-1.3% year-on-year) signal a loss of economic momentum.

Waning price momentum amplifies concerns. The CPI remained stagnant at 0% in July, and August data might see inflation dip into negative territory.

Consensus forecasts project a 0.2% year-on-year decline, with some domestic firms, like China International Capital Corp (CICC), anticipating a steeper 0.4% fall, according to Wall Street CN, citing high base effects and weak food prices.

The Producer Price Index (PPI) trend also paints a concerning picture. Industrial sectors continue to experience disinflation, reflecting sluggish final demand and falling raw material prices.

Beijing’s Balancing Act: Deflation and Economic Restructuring

Chinese policymakers face a growing economic conundrum. On one hand, authorities have intensified their “anti-involution” efforts, a series of measures aimed at reducing production overcapacity, streamlining competition, and supporting prices in key industrial sectors.

Conversely, these policies could potentially impact short-term employment, particularly in low-productivity or highly indebted industries.

BNP Paribas analysts suggest that “the success of this strategy hinges on the government’s ability to provide sustainable support for domestic demand.”

However, initiatives have been cautious. Despite consumer subsidies, child allowances, and targeted interest rate cuts, household spending remains fragile, with retail sales growth slowing to 3.7% in July, down from over 5% in the first half of the year.

August CPI: A Crucial Economic Indicator

Wednesday’s Chinese inflation data will be more than just a number; it will serve as a litmus test for the credibility of Chinese economic policy.

If a return to deflationary territory is confirmed, markets may anticipate a more robust response from authorities, potentially in the form of monetary easing or new fiscal measures to bolster demand.

As for the Yuan, it may continue to strengthen against the US Dollar (USD) in the near term, barring any positive surprises in price data or unexpected policy developments.

Disclaimer: This information is provided for educational purposes only. Past performance does not guarantee future results.