China’s Deflation Spurs Dollar Retreat, Stimulus Hopes
London – The dollar weakened on Wednesday after data showed that the Chinese economy slipped into deflation last month. This sparked speculation that the Chinese government would implement additional stimulus measures, leading investors to turn towards risk assets.
According to dealers, dollar selling by state-owned Chinese banks contributed to the rally of the yuan, despite the country’s deflation. The Chinese central bank’s exchange-rate fixing of 7.1588 per dollar before the open was stronger than expected, signaling discomfort with the recent declines of the yuan.
The dollar index, which measures the U.S. currency against several others including the euro and sterling, fell 0.22% to 102.29. This follows a 0.47% rise in the previous session.
The euro and sterling both experienced gains, rising 0.3% and 0.16% respectively. European markets also rebounded after a decline caused by the Italian government’s decision to impose a surprise 40% windfall tax on banks. Although the finance ministry later softened its stance, major euro zone lenders’ shares dropped by 3.5% initially.
Chinese consumer prices saw its first decline in over two years in July. Despite expectations of safe-haven appeal for the dollar, some investors believed that the Chinese government might opt for monetary stimulus to stabilize the economy.
“There’s still no signs yet from officialdom of imminent support” for the Chinese economy, noted Ray Attrill, head of foreign-exchange strategy at National Australia Bank. He also said that the dollar index will remain “pretty well supported” above 102, but the likely near-term ceiling is 103.
Meanwhile, the Australian dollar rose 0.13% to $0.6553, recovering slightly from its lowest level since June 1. The New Zealand dollar also rebounded, increasing by 0.16% to $0.6074 after hitting a two-month low.
The market is eagerly awaiting U.S. inflation data set to be released on Thursday. This data carries more weight for investors than the decline in price pressures in China. According to Daiwa Capital Markets head of economic research Chris Scicluna, central banks such as the Federal Reserve, European Central Bank, and Bank of England are primarily concerned with services prices and the tightness of labor markets, which will not be influenced significantly by the situation in China.
Overnight, there were dovish signals from Fed officials, with Philadelphia Fed President Patrick Harker suggesting that interest rates are already high enough, aligning with Atlanta Fed President Raphael Bostic’s view. However, Fed Governor Michelle Bowman stated on Monday that further interest rate hikes are likely.
Money market traders are still heavily favoring a quarter-point rate increase at the next policy meeting in September, with odds currently at 86.5%.
– Additional reporting by Kevin Buckland in Tokyo; Additional reporting by Brigid Riley; Editing by Sonali Paul & Simon Cameron-Moore