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Yuan, Inflation and Expectations

The big news is that China will be going off the peg to the U.S. dollar.  Studies indicate that the Chinese currency is between 25% and 40% undervalued in dollar terms.  Of course this doesn’t help since the implication is that the undervaluation of the Yuan against the Euro was even more extreme!  

China is Canada’s third largest trading partner, overtaking Japan in 2008, to take on about 3% of all Canadian trade (62% of all trade is with the U.S.).  So what is the impact of a re-valuation of the Yuan on Canada’s trade position?  First, a revaluation of the Yuan (lets say the authorities allow a 5% appreciation) is almost meaningless since the Canadian dollar over the past 5 years has gained approximately 30% against the U.S. dollar, and by the same amount against a pegged Yuan.

It will affect Canada’s producer price index (PPI), but its unclear how much of this production cost increase will pass on to the consumers.  Overall, the link between China and Canada is too inconsequential to mean anything to the Canadian economy.  The pressures on the Canadian dollar are driven by the energy complex (and the S&P 500).  

Aside from that very little economic news out for Canada this week.  Inflation is the big number, and will feed the flame for additional increase in interest rates.  Although the bank of Canada has been sounding the alarm on global economic conditions:

  • 21 Jun 2010 15:29 BST *DJ BOC: Overall Level Of Risk To Financial Stability Has Increased
  • 21 Jun 2010 15:29 BST *DJ BOC: Risk Of Another Period Of Severe Stress In Financial Markets, Global Banking Sector
  • 21 Jun 2010 15:29 BST *DJ BOC: Steps Taken In Europe In May Fall Short Of Lasting Solution To Fiscal Woes
  • 21 Jun 2010 15:29 BST *DJ BOC: Countries Need Realistic Plans To Achieve Sustainable Fiscal Positions
  • 21 Jun 2010 15:29 BST *DJ BOC: Europe Fiscal Woes A Risk To Timely Resolution Of Global Imbalances
  • 21 Jun 2010 15:29 BST *DJ BOC: More Flexible Exchange Key In Resolving Global Imbalances
  • 21 Jun 2010 15:29 BST *DJ BOC: Sees "Transitional Challenges" Form Implementation Of Bank Capital Rules
  • 21 Jun 2010 15:29 BST *DJ BOC: Downside Risk To Canada Financial System From Global Downturn Has Risen
OK someone is clearly not staying on message.  But then as I have often indicated, Canada’s “good-ish” economic health allows the authorities to be a bit more honest than in Europe or South of the border.  

The jury is out on what will happen over the next few months.  

CAD at parity (consistently by Q4/10)
GDP growth for 2010 3.2% -- implication is that Q3 & Q4 will be very weak.

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