Business

China fuels fears of currency war by setting weak yuan target rate

Kyodo, Bloomberg

The Chinese central bank on Thursday set the yuan reference rate weaker than 7 to the U.S. dollar for the first time in 11 years and three months, deepening fears that the ongoing China-U.S. trade war will escalate into a currency conflict.

The People’s Bank of China set its daily reference rate at 7.0039 yuan per dollar, 0.06 percent weaker than the previous day. The rate was last at the 7 yuan level in May 2008.

The central bank has set weaker daily reference rates for six consecutive trading days since Aug. 1 amid an escalating trade dispute with the United States, fueling speculation among market participants that Chinese currency authorities are tacitly allowing the yuan to weaken.

A weaker yuan is expected to boost exports by making Chinese-made products cheaper and pushing up the value of overseas revenue in yuan terms.

The yuan is allowed to trade up or down by 2 percent around the reference rate.

China’s daily currency fixing has become a hotly watched event after a weak reference rate on Monday helped trigger the biggest loss in the yuan since 2015 and spark concern about a global currency war.

The U.S. Treasury Department designated China as “a currency manipulator,” saying that China has “a long history of facilitating an undervalued currency” and in recent days has taken concrete steps to devalue its currency.

China has denied the allegation as groundless, with Foreign Ministry spokeswoman Hua Chunying urging the United States to “come back to reason and correct its wrongdoing as soon as possible, lest it should further undermine China-U.S. relations.”

Some market participants have fretted that the United States may intervene in the foreign exchange market to weaken the dollar against the yuan in a bid to counter China’s alleged currency manipulation.

The yuan plunged after President Donald Trump said last week that the United States will levy 10 percent tariffs on an additional $300 billion worth of Chinese imports from Sept. 1, a move likely to further drag down China’s economy.

The latest move comes after the PBOC took steps to calm sentiment toward the yuan, reassuring foreign companies that the currency won’t weaken significantly and planning to sell bonds in Hong Kong.

“China wants to prevent panic now,” said Gao Qi, a strategist at Scotiabank. “The PBOC will continue to send signals to stabilize the yuan in the near term.”

The yuan is down 3.7 percent in the past three months, and at its lowest since at least 2015 against a basket of currencies.

Further depreciation is still on the cards. U.S. President Donald Trump has threatened to impose more tariffs on Chinese goods and the PBOC could loosen its monetary policy to aid growth. Central banks in New Zealand, India and Thailand all made surprise interest-rate cuts on Wednesday, stoking fears of a full-on currency war.

Yet China will be keen to avoid the experiences of 2015-2016, when a one-off devaluation spurred companies and individuals to yank money out of the country.

“I suspect the authorities will want to gain more comfort over the next few days and weeks that we’re not seeing a huge intensification of capital outflow pressures, before they possibly allow it to go a little weaker,” said Andrew Tilton, chief Asia Pacific economist at Goldman Sachs Group Inc. “Right now I suspect they want to desensitize the market to this magic number of 7, and make sure that they are not going to have a capital outflow problem.”

The risk is how the Trump administration responds to a weaker yuan. The U.S. this week labeled China a currency manipulator, a formal designation which China rejects. The yuan may tumble to as weak as 7.7 in the event of an intensification of trade tensions, according to Societe Generale SA.

“The further it falls, the more likely the Trump administration will respond with more tariffs and other policies to target China,” said Ben Emons, managing director for global macro strategy at Medley Global Advisors in New York. “All of which points to even more downside in the RMB, which is then a problem for other emerging countries that compete with China,” he said, using an abbreviation of the yuan’s official name.

That means the PBOC’s reference rate is going to continue to be closely watched by traders and central bankers alike.

“The fix is the number one game in town and will continue to dictate the pace of play for risk assets over the near-term,” said Stephen Innes, managing director for VM Markets Ltd. in Singapore. “Nothing else matters at this stage.”