China central bank adjusts yuan fix factors to keep FX market stable

BEIJING/SHANGHAI (Reuters) - China’s central bank said on Friday that it was adjusting its methodology for fixing the yuan’s daily midpoint in order to keep the currency market stable, amid broad dollar strength and ongoing trade tensions between Washington and Beijing.

FILE PHOTO: A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

The yuan CNY=CFXS surged more than 400 pips to trade at 6.8412 against the U.S. dollar as of 1255 GMT in late night trading after the People's Bank of China (PBOC) announced the change on Friday.

But the currency has still depreciated by about 5 percent since the start of the year, partly reflecting concerns over debt levels in the economy, and gloomier prospects for economic growth and exports due to China’s escalating trade dispute with the United States.

The PBOC said the “pro-cyclical market sentiment” driving the yuan’s slide had persuaded it to resume use of a “counter-cyclical factor” when it fixes the yuan’s daily mid-point.

“Affected by the recent strong dollar index and trade frictions, there have been some pro-cyclical activities in the foreign exchange market,” the PBOC said.

The central bank said the revival of the “counter-cyclical factor” would help the yuan to remain basically stable at a reasonable and balanced level.

The PBOC announcement confirmed a Reuters story earlier in the session.

Analysts say the PBOC’s aim would be to stop a herd mentality from developing in the currency market, which would run the risk of accelerated capital outflows.

Several analysts suspected it was a precautionary move by the PBOC to bolster the yuan while the trade row with Washington drags on.

“There was no breakthrough in the Sino-U.S. trade talks, and the negotiations between the two sides are expected to become a protracted war. The central bank has to take out measures step by step to stabilize the exchange rate,” said Ken Cheung, senior Asian FX strategist at Miuzho Bank in Hong Kong.

“Whether the yuan will start to appreciate is still largely dependent on the progress of the trade war.”

U.S. and Chinese officials ended two days of talks on Thursday, with no major breakthrough as their trade war escalated with activation of another round of dueling tariffs on $16 billion worth of each country’s goods.

While no deal had been expected by markets, the focus is now shifting to far more sweeping U.S. tariffs, on another $200 billion of Chinese goods, which are expected to go into effect in late September.

At that point, Beijing would have little scope to match any more U.S. measures on a dollar-for-dollar basis, as China imports fewer American goods.

That is fuelling worries Beijing may resort to other forms of retaliation, ranging from actions against U.S. firms in China to allowing the yuan to weaken further.

The PBOC has rolled out a slew of counter-cyclical measures over the past few weeks.

It reinstated a reserve requirement ratio of 20 percent in early August for financial institutions settling foreign exchange forward dollar sales to clients, effectively raising the cost for investors shorting the yuan.

Regulators again on last Thursday barred banks from using some interbank accounts to deposit or lend yuan offshore through free trade zone schemes, two sources with direct knowledge of the matter told Reuters. The changes tightened yuan liquidity offshore and made it more expensive to short the currency.

“The yuan is likely to face some upward correction in the near term to about 6.8 per dollar level,” said a trader at a foreign bank.

The PBOC had reduced the influence of the “counter-cyclical factor” in January to loosen control over the exchange rate, but there Beijing has become more uneasy over the yuan’s depreciation in recent months, according to analysts.

China introduced the “counter-cyclical factor” in 2017 in what regulators said was an effort to better reflect supply and demand, lessen possible “herd effects” in the market and help guide the market to focus more on macroeconomic fundamentals.

Reporting by Reuters Shanghai bureau; Editing by Simon Cameron-Moore