Why China’s central bank supports the yuan

The Chinese yuan has fallen to its lowest level in two years against the US dollar in recent weeks.

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BEIJING — China’s central bank has sent a strong signal that it wants to prevent the Chinese yuan from weakening too quickly against the U.S. dollar, economists said.

For the second time this year, the People’s Bank of China announced on Monday that it would reduce the amount of foreign currency banks must hold.

Such moves theoretically reduce weakening pressure on the yuan, which has fallen more than 8% this year to two-year lows against the US dollar.

Chinese authorities typically focus on the level of the yuan against a basket of currencies, against which the yuan has strengthened by around 1% over the past three months.

However, Beijing’s latest actions show just how important the yuan-dollar exchange rate still is, Nomura’s chief China economist Ting Lu and a team said in a report on Monday.

They gave two reasons:

  • “First, in a year of leadership reshuffles that only happens once every ten years and with US-China tensions high, Chinese leaders are particularly concerned about the bilateral exchange rate of the RMB with the USD because they think the RMB/USD somehow reflects relative economic and political strength.
  • “Second, a sharp depreciation of RMB/USD could shake domestic sentiment and accelerate capital flight.”

The ruling Chinese Communist Party is due to select a new group of leaders in October, while strengthening the power of President Xi Jinping.

Tensions between the United States and China have escalated in recent years, resulting in tariffs and sanctions against Chinese tech companies.

Meanwhile, China’s economic growth has slowed over the past three years, especially with the shock of the pandemic in 2020. Tighter Covid controls this year, including a two-month lockdown of Shanghai, have prompted many economists to reduce their GDP forecasts to close to 3%.

This economic slowdown has contributed to the weakening of the yuan, which may help make Chinese exports cheaper for buyers in the United States and other countries.

The US dollar has strengthened significantly this year as the US Federal Reserve has aggressively tightened monetary policy.

Additionally, the greenback – as measured by the US dollar index – benefited from 20-year lows in the euro and a similar fall in the Japanese yen.

Levels to watch

“We think the PBOC may tolerate further depreciation of the CNY against the USD, especially as the broader USD continues to strengthen, although it may want to avoid continued depreciation and too much quick one-way if possible,” Goldman Sachs analyst Maggie Wei and the team said in a report Monday.

Analysts said they expected the yuan to depreciate 7% against the dollar over the next three months. Nomura FX analysts forecast a level of 7.2 by the end of the year.

The yuan last traded near 7.2 against the dollar around May 2020 and September 2019, according to data from Wind Information.

“I don’t think it will go much beyond [7]certainly somehow beyond the 7.2 we saw during the trade war,” Julian Evans-Pritchard, senior China economist at Capital Economics, told CNBC’s “Squawk Box Asia” on Tuesday.

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“I think that’s the key threshold,” he said. “I think the reason they’re reluctant to allow that to happen is that if it goes beyond that level, expectations about currency risk become unanchored. You’re likely to see capital outflows on a much larger scale. .”

The PBOC on Tuesday set the midpoint of the yuan against the dollar at 6.9096, the weakest since Aug. 25, 2020, according to Wind Information. China’s central bank loosely controls the yuan by setting its daily midpoint based on recent price levels.

PBOC: Do not bet on a specific point

The PBOC’s latest reduction in the foreign reserve ratio – from 8% to 6% – is expected to take effect on September 15, according to an announcement on the central bank’s website Monday.

Earlier on Monday, PBOC Deputy Governor Liu Guoqiang said that in the short term, the currency is expected to fluctuate in two directions and people “shouldn’t bet on one specific point.”

That’s according to a CNBC translation of a Chinese transcript of Liu’s remarks at a press event on economic policy.

In the long run, Liu maintained Beijing’s hopes of greater international use of the yuan. “In the future, the recognition of the yuan in the world will continue to increase,” he said.

– CNBC’s Abigail Ng contributed to this report.


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