Since December 2009, the yuan has appreciated almost four percent, while this figure is much closer to ten percent for most EMEs. The comparison is even more dramatic when looking at a longer period of time. This has been achieved through massive reserve accumulation and limited financial integration. However, for measures in the foreign exchange market to have real effects – that is, on the real exchange rate, which is the relevant variable from the point of view of competitiveness – these measures need to have some support from the real side of the economy. In the case of China, this is a very high savings rate. China saves about half of its GDP and the resulting current account surplus sustains a depreciated real exchange rate. Otherwise, attempts to maintain a depreciated nominal exchange rate sooner or later lead to inflation, which is the way to achieve relative price adjustment when the nominal exchange rate is not allowed to adjust. The U.S., in turn, is undertaking an extraordinary monetary expansion. Beyond having reached the zero lower bound for the federal funds rate, unconventional measures are adding additional monetary stimulus. In particular, the massive purchase of securities implemented in the so-called QE2 program. This explains why the dollar has reached its lowest level in several decades (Figure 3), but this is not only the result of expansionary monetary policy, but also of the lack of domestic demand and of the external imbalances.
My point is rather that it is not surprising that central bank asset purchases may break with some of the regularities we have become used to. The reason is that asset purchases are monetary policy actions that can be anticipated by market participants, just like changes in key policy rates. Unlike conventional monetary policy, however, they have direct implications for the expected supply of and demand for internationally traded bonds and, hence, for the level of the exchange rate that, all other things being equal, clears the resulting capital flows. This may, at times, break the link between future expected rates and the exchange rate. This is clearly visible when we look at slide 6. The chart is based on the same methodology as the spillover chart on slide 4, but it illustrates how much, on average, of the variance in long-term bond yields in one country can be explained by the other country’s term premium and expected short-term rates respectively. 7 / 11  BIS central bankers' speeches  You can see that the moment short-term yields hit the zero lower bound, spillovers in bond markets by and large reflected term premia movements – in both directions. These spillovers may pull the exchange rate away from the path implied by expectations about the future shortterm rate. The extent of the decoupling, in turn, will depend on the expected direction, persistence and degree of international spillovers – something that is inherently difficult to project and price.