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New upward pressure on the exchange rate?

Donita Rodríguez - Head of Macroeconomic Analysis

30/01/2020

Article published in El Comercio.

The first three weeks of the year started with a relative calm exchange rate of the sol against the dollar. As a matter of fact, this fluctuated around 3.32 soles per dollar, lower in with regard to the rate observed in November 2019, (3.39 soles per dollar), the month in which the North American currency maintained its appeal as a safe asset due to heightened uncertainty amid the trade war between the U.S. and China, as well as Brexit.

“In the past week, a new risk to global growth has arisen: the rapid spread of the coronavirus.”

“Esta es una cita de ejemplo”

This relative calm of the exchange rate is mainly related to two items of news that improved this year’s prospects of the performance of the global economy. Firstly, after 18 months of continuous economic downturn, at the end of 2019, signs of a stabilization of global growth became discernible. This, due to actions taken by the central banks to boost the economy, such as the reduction of the reference interest rate from Q3 2019 onwards. Secondly, the risk of an increased downturn of global growth after solving and the subsequent signing of Phase 1 of the trade deal between the U.S. and China. This generated increased optimism among global financial investors about the perspectives of China’s economic recovery and, as a result, the prices of some industrial metals recovered in comparison to the average prices registered in November (the price of copper rose by 6%.)

Both factors increased international investors’ risk appetite once again, which translated into a higher demand for bonds from emerging economies. In fact, the Institute of International Finance estimates that in December, the flow of capital into emerging economies was US$ 10 billion higher in comparison to November.

Nevertheless, in the past week a new risk to global growth has arisen: the rapid spread of the coronavirus. It’s likely that the safety measures adopted by the Chinese government will affect the country’s economy during the first quarter of the year. This is due to the fact that the extension of labor days lost, the restriction on the freedom of movement of people and the closure of entertainment businesses could affect the growth of the consumption markets –restaurants, leisure centers, tourism, amongst others– and the manufacturing output. The worry generated by the risk of an increased spread of the virus and its impact on the Chinese economy have produced drops on different stock markets. Likewise, since this risk has increased, within one week the price of copper has shrunk by 7%, the dollar has strengthened by close to 1% and the sol has depreciated by 1% against the dollar.

Given this scenario, it will be important to monitor the impact that this new risk could generate on the price of copper and the exchange rate. If coronavirus infection cases continue to increase, investors’ fear will grow too and could translate into a decreased risk appetite.

Hence, more assets considered risk-free would be needed (such as the dollar and gold), and currencies of emerging economies (such as the sol), could experiment upward pressures, as we’ve already seen so far.

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