The Chinese currency is expected to weaken after China’s latest rate cut, but the depreciation will not be sharp, according to United Overseas Bank (UOB) Global Economics & Markets Research.

Last Saturday, The People's Bank of China (PBoC) lowered its key interest rates for the second time in three months, with symmetric reductions of 25bps for both deposit and lending rates. It also further liberalised the interest rate market by raising the deposit rate ceiling.

“We maintain our view that the renminbi will be on a weakening path against the US dollar, as the US Federal Reserve is poised on normalising its interest rates and the spread between US and China interest rates turns further against the renminbi.

“However, we believe the depreciation of the renminbi is likely to be contained, and a sharp devaluation is a low probability scenario for now. A substantial decline in the renminbi would be problematic for China in terms of international relations, credibility of internationalisation of the renminbi and capital outflows,” said UOB in a note today.

UOB is maintaining its forecasts for renminbi at 6.28/USD for end-1Q2015, 6.33/USD at end-2Q2015, and at 6.29/USD for end-2015. It also thinks trading bands could widen from 2% currently to 3% before end-2015.

The Singapore-based research house said China’s full interest rate liberalisation could happen by the next one to two interest rate cut announcements.

“With both interest rate cuts and reserve requirement ratio cuts (announced on Feb 4) in 1Q2015 within our expectation, we maintain our view that the PBoC would make another round of cuts in 2Q2015 before pausing to see how the effect would pan out for the broader economy.

“A sharp decline in consumer prices could mean a sharper response from the central bank, although one should keep in mind the negative effect on savers as deposit rates fall toward the zero bound.”

UOB noted that the latest policy decision takes effect from March 1, just days before the start of China’s important National People’s Congress and Chinese People’s Political Consultative Conference.

Timing-wise, the move shows that the central bank is proactive in providing policy support to the government’s reform agenda, and in responding to the global phenomenon of falling inflation, said UOB.

According to the research house, this latest interest rate cut by the PBoC did not come as a surprise as China is facing a challenging economic environment.