Policy options do not include renminbi weakness.
Foreign exchange intervention from the PBOC this week has been aggressive with the renminbi posting its largest 3-day percentage change since 2005 when it switched to a managing float. This intervention increases the chance that the PBOC will be forced to cut the RRR and a move as early as this weekend should not be ruled out.
The rationale is simply that the PBOC will look to re-inject domestic liquidity that has been removed through its FX intervention. During the phase when FX reserves were growing and the PBOC was selling domestic currency the converse happened as the RRR was raised. We should not read an adjustment of the RRR as an easing of policy and the PBOC will be cognizant of creating too much liquidity.
In addition to FX intervention the PBOC has this week also taken a step toward signaling its desire for lower money market rates. Despite cutting interest rates twice since Nov last year we have seen money market ratres remain stubbornly higher. The fact that money market rates have not been responding appropriately suggests that capital outflows have further tightened money market liquidity as well as weigh on the renminbi.
More broadly FX intervention is an important signal at a time when some commentators have debated the merits of currency depreciation for China. We continue to think that policymakers will favour stability rather than be seen adding to concerns over a currency war. Policy easing will come through a combination of rate and RRR cuts and the renminbi is not included in the list of policy options.