(Bloomberg) -- China stepped up its support for the yuan as the managed currency weakened toward a policy no-go area — the edge of its allowed trading range against the dollar.
The central bank set a daily reference rate that was stronger than analyst estimates by the most since April on Wednesday, with the currency approaching a record low offshore this week. State-owned banks continued to scale back their yuan lending in Hong Kong, making it costlier for investors to build short positions, traders said.
The moves suggest China is not yet ready to let go of its tight grip on the currency, despite pressure coming from a yawning interest-rate discount to the US, looming tariff threats and a sluggish local economy. Beijing fears disorderly capital outflows that can result in a panic selloff of yuan-denominated assets and derail an already lackluster recovery.
However, its strategy carries a cost, opening up the prospect of trading glitches or thin liquidity the closer the yuan comes to its permitted limit. And propping up the currency has sent it to around a two-year high against a basket of peers — a move that may hurt Chinese exporters.
“The authorities are clearly unwilling for one-sided speculation to snowball at this point,” said Fiona Lim, a senior strategist at Malayan Banking Bhd. in Singapore. But “I would not be surprised if the People’s Bank of China relents on the fix a tad more if threats of tariffs turn into reality that could undermine growth.”
On Wednesday, the PBOC set the so-called fixing at 7.1887 per dollar, 1,528 pips stronger than the average estimate in a Bloomberg survey of traders and analysts. That was the widest gap since April and is interpreted by market watchers as an effort by authorities to guide the currency in a certain direction.
The daily rate limits moves in the onshore yuan to 2% on either side and is China’s favorite tool when it comes to guiding expectations.
Still, traders continued to push the yuan weaker in the spot market, with the currency deviating some 1.99% from the fixing. A string of disruptions took place in the derivatives market last time the yuan got this close to the weak end of the trading band.
Other Tools
A surge in yuan’s borrowing cost in Hong Kong this week also reflects expectations that the PBOC may enlist other tools like squeezing offshore liquidity to damp bearish bets.
The yuan’s overnight interbank rate in Hong Kong climbed to 8.1% on Tuesday, the highest since 2021, before easing on Wednesday. The one-month rate gained for a third day to 4.45%, highest since April.
In the onshore market, state banks sold the dollar against the yuan at levels close to 7.3320, according to traders who are not allowed to comment publicly on the FX market. The yuan was little changed in domestic trading at 7.3316 per dollar on Wednesday.
“The PBOC appears determined to support the yuan,” said Alvin T. Tan, head of Asia FX strategy at RBC Capital Markets. The central bank is aiding the currency “not just with the onshore daily fixes, but also through the extremely high offshore funding rates.”
In another clear sign of official concerns, the central bank vowed in a readout of its latest quarterly monetary policy meeting to crack down on behavior that disrupts the market and prevent the building of one-sided bets as well as any overshoot in the exchange rate.
Local media outlet Yicai reported on Monday that the PBOC was planning to increase bill auctions in Hong Kong, a move that can soak up yuan liquidity in the city and also make it more expensive to short China’s currency.
Analysts still expect the yuan to weaken further this year considering China’s economic fundamentals and US President-elect Donald Trump’s tariff pledges.
“When spot is near the extreme weak side of the daily band, fear of yuan depreciation leads to hoarding of FX and an increased supply of FX to the market from state banks and official sector,” Nomura strategists including Craig Chan wrote in a note.
“Although some of the tariff risk might be in the price, we still believe this will lead to a break higher in dollar-offshore yuan” if Donald Trump imposes an additional 10% tariffs on China on his inauguration day.
--With assistance from Chongjing Li, Ran Li, Qizi Sun and James Mayger.
(Updates throughout)
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