China Uses Another Tool to Aid Yuan in String of Market Support

China moved to support the yuan by increasing the supply of foreign currency in its local market, part of a multi-pronged effort by Beijing to restore confidence amid sluggish growth.

(Bloomberg) — China moved to support the yuan by increasing the supply of foreign currency in its local market, part of a multi-pronged effort by Beijing to restore confidence amid sluggish growth.

Financial institutions will need to hold just 4% of their foreign-exchange deposits in reserve starting Sept. 15, the People’s Bank of China said Friday, compared to the current level of 6%. The greater availability of overseas currency relative to the yuan effectively boosts the allure of the latter.

The so-called FX RRR cut came on the heels of Thursday’s reduction in down payments for mortgages to help the country’s under-pressure residential property market and after policymakers lowered stamp duty for stock trading over the weekend. The combination of supportive measures is a sign that Beijing is growing uncomfortable with increasing pessimism in its financial markets.

“The pickup in the pace of providing more support is very evident, though so to me it’s more a matter of when there is a turning point in sentiment,” said Eddie Cheung, senior emerging market strategist at Credit Agricole CIB in Hong Kong. 

The offshore yuan rose as much as 0.5% after the move before paring gains to trade up 0.1% around the 7.2666 per dollar level.

China’s currency tumbled toward its weakest level since 2007 against the dollar in August, after a surprise interest-rate cut failed to boost investor sentiment damaged by ongoing economic weakness. The currency has fallen around 5% this year amid China’s yawning rate divergence with the US and is among Asia’s worst performers next to the yen and Malaysian ringgit.

“Unconstrained weakness in the currency can become self-fulfilling via expectations,” said Sameer Goel, global head of emerging markets and APAC Research at Deutsche Bank AG. “The authorities in China have both ability and reason to lean against the pressure.”

Despite the strong signal Friday’s move carries, the limited impact it had suggested analysts still want more.

“Previous experience suggested that the yuan will be supported briefly by similar measures, but it has not been a step to turn around the direction of dollar-yuan in the medium-to-long term,” said Becky Liu, Head of Greater China Macro Strategy at Standard Chartered. 

The PBOC has ramped up support for the currency via tools such as setting stronger-than-expected daily reference rate, prompting state banks to sell dollars and tightening offshore yuan liquidity to squeeze shorts. The cut to FX RRR was last deployed the tool in September.

According to Wang Qing, chief macro analyst at Golden Credit Rating International, Beijing may next deploy more tools such as making it more expensive for bears to short the currency with forwards.

Chinese stocks climbed on Friday, with the CSI 300 Index rising as much as 1.2%. A gauge of property shares outperformed after the moves to cut down payment and mortgage rates.

Also on Friday, the PBOC set its daily reference rate — which limits the moves in onshore yuan by 2% on either side — more than 1,000 pips stronger than the average estimate in a Bloomberg survey. That’s another sign Beijing is determined to stabilize sentiment in the currency market. 

The reduction in FX RRR arrived before keenly watched US employment data later Friday. A strong reading may fuel bets for the Federal Reserve to hike rates further, supporting the dollar and hurting the yuan.

China’s move is “in line with the PBOC’s defense of 7.30 and in combination with the other measures will be more powerful,” said Rob Carnell, regional head of research, Asia-Pacific at ING Groep NV. “I’m not convinced it changes the outlook longer term, but the US data is also now turning, so it does buy time as we wait for a broader based turn in the dollar.”

–With assistance from Chester Yung.

(Updates throughout.)

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