Caixin
Aug 08, 2019 08:29 PM
FINANCE

China’s Central Bank Hits Milestone as Yuan ‘Breaks 7’

The yuan has dropped 2.3% against the dollar so far in August, although it recovered slightly on Thursday to close at 7.0443. Photo: IC Photo
The yuan has dropped 2.3% against the dollar so far in August, although it recovered slightly on Thursday to close at 7.0443. Photo: IC Photo

China’s central bank set the yuan’s daily reference rate at 7.0039 to the U.S. dollar on Thursday, the first time it has set the midpoint (link in Chinese) weaker than the key psychological threshold of 7 yuan since the global financial crisis in 2008. The move could exacerbate trade tensions with the U.S., which on Monday branded China a currency manipulator.

The rate, which is announced every day at 9:15 a.m. Beijing time, was set 43 pips weaker than the previous day and was the sixth straight day of weaker fixings, reflecting the currency’s decline against the dollar in the onshore spot market. The yuan has dropped 2.3% against the dollar so far in August, although it recovered slightly on Thursday to close at 7.0443.

Traders had been expecting the yuan fixing to “break 7,” after the currency crossed what had been seen as a red line for the People’s Bank of China (PBOC) in both the mainland and offshore markets earlier this week.

The central bank set off a global panic on Monday when it set the daily reference rate for the yuan, also known as the renminbi (RMB), 229 pips weaker at 6.9225, the first fixing below 6.9 this year. The move, which followed U.S. President Donald Trump’s threat on Thursday U.S. time to impose tariffs on more Chinese exports, sent the yuan crashing against the dollar. It broke through the 7.0 level in both the onshore market in Shanghai, where most trading takes place, and in the offshore markets, which are dominated by Hong Kong, London and New York.

The PBOC has previously intervened in the currency market to prevent the yuan from sliding beyond 7 per dollar, but on Monday it appeared to stay on the sidelines as the currency remained past the key level, fueling expectations that it is prepared to see further weakness.

More flexible

“We doubt the PBOC would have taken this step if it wasn’t willing to let the currency depreciate further,” Julian Evans-Pritchard, senior China economist with research firm Capital Economics, wrote in a note on Thursday. “It’s true that the renminbi’s move past 7.00 will put further strain on U.S.-China relations. But we think that trade negotiations between the two countries would have broken down anyway, even if the PBOC had continued to defend 7.00 against the dollar.”

The PBOC manages the yuan’s value and the daily reference rate is an important benchmark for traders in the foreign exchange market. The currency is only allowed to trade 2% above or below the reference rate, which is set based on several criteria, including the previous day’s closing price and submissions from major banks.

The central bank has increasingly allowed the currency to move in line with pressure in the foreign exchange market, said Louis Kuijs, head of Asia economics at Oxford Economics, an analysis and forecasting group.

“While it has tinkered with the fixing mechanism, the PBOC has intervened little on the FX market in recent months,” he wrote in a research note Monday. “In our view it will continue to preserve the right to step in when it feels it should. But we think today’s move is also in line with a trend towards increased flexibility.”

The PBOC has pushed back against accusations that it is deliberately weakening the yuan amid deepening trade tensions with the U.S. and rejected the U.S. Treasury Department’s designation of China as a currency manipulator.

“Recent RMB depreciation since the beginning of August has been driven and determined by market forces and reflects shifts in market dynamics and volatilities in global foreign exchange markets amid global economic developments and escalating trade frictions,” it said in an English-language statement on Tuesday. It called the U.S. move as a “capricious act of unilateralism and protectionism” that will severely undermine international rules and have a material impact on the global economy and finance.

Stable anchor

The comments followed a statement by PBOC Governor Yi Gang on Monday that China remains committed to a market-oriented exchange rate system and will not use the yuan’s exchange rate “as an instrument in dealing with trade disputes or other external disruptions.”

The PBOC’s actions mean “global markets and policymakers will have to get used to a more market-driven yuan and the greater variability that comes along with that,” said Kuijs from Oxford Economics.

“By itself, it is about time that China’s currency becomes more market-determined and flexible. But this also means that a currency that until recently had been always a relatively stable anchor on global FX markets is likely to move more in the future,” he said.

Contact reporter Guo Yingzhe (yingzheguo@caixin.com)

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