China's central bank said on Friday that it expected the dollar to strengthen this year, but it raised the specter of worldwide asset bubbles and inflation.
In a lengthy report on the global financial markets, the People's Bank of China also warned that huge, hidden bad bank loans in the West could pose a threat to the global economy.
While the dollar is likely to rebound this year if the Federal Reserve raises interest rates earlier than other major economies and sovereign-debt problems in the euro zone persist, huge U.S. fiscal and trade deficits could limit its gains, the report said. "Therefore, even if there is a rebound in the dollar, the rebound will be not be too strong," the report said.
The central bank said the ultra-loose monetary policies, including quantitative easing adopted by major central banks, had pumped huge liquidity into the global financial markets.
"Once the real economy turns better, the massive liquidity being released out will definitely add to inflationary pressure," the bank said.
"It is an urgent task faced by central banks in the world to avoid the forming of asset bubbles and inflation."
"We cannot rule out that the recovery process may reverse due to the exit of expansionary monetary policies," the People's Bank of China said in its 2009 International Financial Markets Report.
The central bank also highlighted risks of downgrading of sovereign credit ratings in some major economies, including the United States and Britain.
The central bank report was released as China comes under growing international pressure to let its currency appreciate — something it has said it may do once the global economic recovery is on a solid footing.
Elsewhere, turning to energy and commodities, the central bank expected modest gains in crude oil prices as the world economic recovery was fragile, while there was limited scope for gold prices to rise.
"There are still factors to push up gold prices in 2010, but the repeatedly refreshed high records in gold prices will depress demand," the central bank said.
The report also comes ahead of Chinese President Hu Jintao's visit to Washington later this month for a nuclear summit. Hu will attend a nuclear security summit in Washington on April 12-13, despite initial uncertainties about whether he would go.
The nuclear summit will open days before the U.S. Treasury is due to release a report on whether China is distorting its currency exchange rate to boost its exports.
Domestic U.S. political pressure has been building on Treasury to label China a "currency manipulator" in its April 15 report on global currency policies, but analysts believe Hu's decision to proceed with the trip is an indication that it will not do so.
China has been facing stiff pressure from the United States and other Western powers which say Beijing is keeping its currency artificially low to give Chinese exporters an advantage in world trade.
Beijing allowed the yuan to rise 21 percent against the U.S. dollar between July 2005 and July 2008 before effectively repegging the currency, also known as the renminbi, near 6.83 to the dollar to help the economy through the global financial crisis.
Central bank governor Zhou Xiaochuan in March hinted the policy of effectively pegging the yuan to the dollar could change, saying it was temporary and would be withdrawn "sooner or later."
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