This weekend the People's Bank of China announced that the yuan-dollar daily trading band would be widened to 2% on either side, from 1%.
China last widened the band to 1%, from 0.5% in April 2012, and to 0.5% from 0.3% in May 2007.
"The primary purpose is to disentangle monetary policy from FX policy," Societe Generale's Sebastien Galy writes.
A market-determined exchange rate is a long-term goal for the central bank. "The hope is a market price for a key macro-economic variable will encourage greater efficiency in resource allocation," writes Bloomberg BRIEF economist Tom Orlik.
"Two-way fluctuations will also discourage speculative inflows and give the central bank greater scope to set an independent monetary policy, ending the low interest rates that have fueled runaway lending and asset bubbles.
While this is an important step towards internationalizing the renminbi and establishing market-based exchange rate, the move was largely anticipated by markets.
The recent "unexpected and rapid depreciation of the yuan in the past few weeks," only fed into the expectations, according to Societe Generale's Wei Yao. This was part of the central bank's efforts to "prepare the market for two-way volatility," she writes.
But markets are now looking for a more meaningful reform out of China.
Yao argues that the band-widening was an easy move for the PBoC, what we need to see is how much control the PBoC would be willing to relinquish with regards to the exchange rate.
"We think that, as the next move, the PBoC needs to be more elusive by moving to weekly or monthly setting of reference rates. Or at least, the trajectory of the daily reference rate should be less directional."
Bank of America's Ting Lu also thinks that any further band widening would be of little consequence, and that "a much more important and meaningful reform is to change the rule on setting the daily fixing of CNY/USD."
Ting expects China to eventually shift to a market-determined foreign exchange regime. "As an intermediate step, China could peg yuan to a basket of currencies weighted by the importance of its trading partners," he writes.
"More specifically, the Singapore’s BBC (Basket, Band and Crawl) regime seems to be favored. A reform towards a real managed float such as the “BBC” system requires a group of more confident and pragmatic political leaders who are true believers of markets."
A change to the daily reference rate could be the central bank's next move. Let's wait and see.
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