PBOC moves to slow yuan rally, capping near-term gains

What happened

China's yuan slid to its weakest level in over two weeks against the dollar on Wednesday, as the People's Bank of China (PBOC) took steps to curb its recent rally. The central bank raised the foreign exchange reserve requirement ratio for commercial banks by 2 percentage points to 6% from 4%. This decision, announced Tuesday, is intended to reduce the supply of dollars in the onshore market, which typically supports the dollar against the yuan.

Furthermore, the PBOC set the daily yuan fixing (midpoint) at a level significantly weaker than the market had anticipated. The reference rate was set around 6.72 per dollar, well below the 6.68 projected by analysts and weaker than the roughly 6.68 seen in mid-October. This direct intervention in the daily fixing reinforces the message that Beijing believes the yuan has strengthened enough for now.

These actions are viewed as one of the PBOC's strongest attempts yet to slow the yuan's appreciation, which has seen the currency gain about 5% against the dollar this year. The CFETS index, which tracks the yuan against a basket of trading partners' currencies, eased from a 52-month high but remains up approximately 5.9% for the year.

Why it matters

The PBOC's intervention signals Beijing's concern about an overly strong currency potentially hurting Chinese exporters' competitiveness. This comes at a time when the Chinese economy is already grappling with weak domestic demand and falling prices. By capping the yuan's rise, the central bank aims to alleviate pressure on exporters, supporting efforts to stabilize economic growth and the stock market, alongside other liquidity measures announced this week.

The move also suggests that the PBOC has more tools at its disposal to manage the exchange rate, which could deter investors from aggressively betting on a renewed and strong yuan appreciation in the near term. Managing the pace of yuan appreciation has been a strategy employed by the central bank throughout the year, seeking a balance between the benefits of a stronger currency and the risks to the export-oriented economy.

Market impact

• Dollar and FX: The PBOC's move is likely to offer some support to the dollar against the yuan in the near term, capping further gains for the Chinese currency. Regional currencies that tend to track the yuan, such as the Australian dollar and the South Korean won, may face mild to moderate pressure, especially amid already fragile risk appetite.

What to watch

Investors will be closely monitoring the PBOC's upcoming daily yuan fixings and any further measures the central bank might implement to manage the exchange rate. The performance of the CFETS index and the reaction of regional currencies will also be key in assessing the effectiveness of the intervention. Additionally, the trajectory of China's economic performance, particularly export data and domestic demand indicators, will provide context for future PBOC decisions.

Scenarios

Base Case: The yuan stabilizes or depreciates slightly in the near term, with the PBOC maintaining control over the pace of appreciation. Risk Case: A more pronounced yuan depreciation if selling pressure intensifies or the PBOC decides to intervene more aggressively to stimulate the economy. Original source: ForexLive (InvestingLive). For information only, not investment advice.