By Dong Zhixin (chinadaily.com.cn)
Updated: 2007-09-19 17:29

RMB strengthened against the US dollar on Wednesday after the Federal Reserve cut the prime interest rate by 50 basis points on Tuesday.

Before trading started on Wednesday morning, the People's Bank of China (PBOC) set the yuan midpoint at 7.5170 against the greenback, compared with 7.5266 on the previous day. The yuan may rise or fall 0.5 percent from the mid-point each day.

Analysts attributed the rise in the yuan's value to a weaker US dollar. The Fed cut the federal funds rate charged on overnight loans between banks to 4.75 percent from 5.25 percent, exerting a downward pressure on the US currency.

The Fed's move put China's central bank in a difficult position, some analysts said.

The PBOC is under pressure to raise the interest rate one or two more times by the end of this year to put inflation in check, while the Fed is widely expected to further cut the federal funds rate at its next policy meeting in October, to prevent the credit crunch from derailing the overall economy.

If both central banks do as they are expected, then the interest spread between the two countries will grow wider. That will lead to a new wave of hot money flowing into China, increasing the pressure on the yuan to appreciate.

The difference in interest rate policies reinforced the dollar's weakening trend and the strengthening trend of Chinese yuan, central bank vice governor Wu Xiaoling said in an interview early this year.

She made the remarks while predicting the Fed would cut interest rate next year and saying the market strongly expected more interest rate hikes by China.

Wu also expressed confidence in the world's largest economy during the interview.

"We believe the consumption-focused US economy has a relatively large amount of flexibility and that the adjustment in the property market will last a long time (but) the US economy will return to a more sustainable level in the coming one to two years."

China's trade surplus jumped nearly 33 percent year-on-year to US$24.98 billion in August, the second highest on record. That surge came even after China took a series of measures, including cutting tax rebates for thousands of export items.

To address this issue, as well as the influx of hot money, some economists have called for faster increases in revaluing the yuan. However, others argued that move would further cut the profit margins of Chinese exporters and might lead to millions of job losses.

Across the Pacific, US lawmakers are threatening trade sanctions unless China revalues the yuan at a faster pace. But the Bush administration has voiced opposition to any unilateral action, while calling for further talks between the two major economies.

China insisted on the gradual reform of the yuan exchange rate and said a stronger renminbi alone could not put an end to the high-flying trade surplus.

The yuan has now appreciated more than 9 percent since RMB ended its peg to the US dollar in July 2005.