Chinese renminbi, being in a free fall, started to worry China’s central bank, which eventually responded quite decisively, reducing the reserve ratio for banks from 8% to 6%. The new policy change will come into effect on September 15. The lower RRR will free up additional liquidity for banks, allowing them to increase lending, thus boosting economic activity. In addition, this measure should spur the flow of foreign exchange liquidity to the currency market, which will reduce speculative pressure on the yuan.

Since the beginning of August, the yuan has depreciated by about 3% against the dollar, reflecting the growing discomfort of investors that a weakening external demand for Chinese goods and the costly measures to combat covid (large-scale lockdowns) will pressure local assets’ expected returns. This in turn, led to a decline in investment demand for Renminbi. It is worth noting that this is not the first time this year that the PBOC has reduced the reserve requirement ratio. The last time it happened was on April 25, when PBOC cut the RRR by 1%, from 9% to 8% after the yuan collapsed against the dollar by 3% in one week.

Large US investment bank Goldman expects the dollar to rise further in the medium term. Along with systemic risks associated with an overheated real estate market in China and Covid restrictions, this should keep CNY under pressure and pushing USDCNY above the 7.0 mark. In addition, according to the bank, PBOC may reduce interventions in foreign exchange market after the 20th Congress of the CCP, which will clear the way for further CNY devaluation.

European stock markets opened higher and European currencies bounced off their lows. The key driver behind the rally are the measures being rolled out by European governments in response to the unfolding energy crisis. Market sentiment has been buoyed by the plan to freeze utility bills at the current level outlined yesterday by the British Prime Minister Liz Truss. The new price containment mechanism won’t be operational until next month and will cost the government £130bn over the next year and a half. In addition to fiscal stimulus, the market is also pricing in the idea that the Bank of England will have more room to hike interest rates.

Germany, Sweden and Finland took a slightly different path. They identified the main risks in the spillover effects on financial sector, so their countermeasures are focused on isolating the energy shock by introducing special credit facilities for enterprises that have been hit. Energy companies in these countries have received additional cheap funding that will allow them to stand on their feet and not provoke a cascade of margin calls in the financial market.

Against the backdrop of the measures taken, EURUSD and GBPUSD rose by an average of 0.4%, Cable traded against Dollar above 1.16, but then rolled back to 1.1550. There is still much potential for an upside for European currencies in the short term as the market is likely to price in less constraints on aggressive tightening by the Bank of England and the ECB. This should potentially help to narrow interest rate differential with the Fed and thus take away some advantage from the greenback. Looking at the GBPUSD technical picture there is clearly room for fresh leg higher as the price broke through short-term downward channel and now look poised to test the upper bound of the medium-term bearish corrid