Under pressure, China finally agreed to ease its exchange rate peg with US dollar. Personally, my view is that this is something that the Chinese central bank will have to do eventually, given that it faces the same 'impossible trinity' that MAS faced a short while ago to control the inflationary pressure. Under fixed exchange rate regime, it is ineffective to control inflationary pressure using interest rate. As discussed in my previous posting, there are already very obvious inflationary pressures in China today. Hence, like it or not, the changes in exchange rate control will have to come sooner or later. Easing the exchange rate peg will help to reduce the prices of imported goods.
Right after this announcement last weekend, the stock markets surged this morning. This is the same short-term effect that you saw in STI after MAS adjusted its exchange rate band recently. This can be easily explained because we would expect the other countries to benefit from this change or ease their exchange rates against US dollar, given that they do not need to hold their exchange rate further to keep their exports as competitive as the Chinese. Equity market should benefit from this.
In the long run, like what I have mentioned before, things will get more expensive because most of our goods esp. clothings and electronics come from China. It will not be easy for companies to relocate their factories to other countries with cheaper factors of productions. Factors like skilled labor force, factories and the necessary infrastructure will take years to build. Hence, we should be seeing inflationary pressure soon.
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