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PBOC Extends Yuan Support as It Boosts Fix by Most Since January

(Bloomberg) -- China’s central bank reinforced its support for the under-pressure yuan by strengthening its daily reference rate for the managed currency by the most since January.

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The People’s Bank of China shifted its fixing by 0.1% with traders still on tenterhooks after the yuan sank to its weakest since November on Friday. The currency rose as much as 0.2% in offshore trading in response to the reference rate and traded little changed around the 7.218 per dollar level onshore.

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The PBOC faces the difficult task of keeping its currency stable while trying to both maintain supportive monetary policy for a sputtering economy and keep a lid on capital outflows. While a weaker yuan may help the export side of the economy, a sharp slide risks triggering the latter given the negative investor sentiment toward China.

“The strong fixing is not unexpected and the yuan will gain beyond 7.20 in no time if this keeps up,” said Mingze Wu, a currency trader of Stonex Financial Pte Ltd. If policymakers “want to have a show of strength it is important that they do increase support. Confidence is very important and gets lost very easily.”

Asia currencies which are usually heavily affected by China sentiment advanced after the fixing, with the Australian dollar edging higher and won extending gains. The PBOC’s reference rate limits moves in onshore yuan to 2% on either side.

As a source of stability in the global FX market and an anchor for its regional peers, any signal from officials that they are open to letting the yuan depreciate risks triggering volatility across an array of currencies. On Friday, the yuan dropped the most in more than two months as traders bet that day’s fixing suggested officials were open to such a depreciation.

Before that session, the yuan had largely flat-lined for nearly two months despite pressure from a lackluster economic recovery and weak sentiment towards Chinese assets. Now a rebound in the dollar and a slump in the Japanese yen are also weighing on the yuan, making support by the PBOC more pressing.

In the derivatives market, investors are paying up for wagers on the Chinese currency that hedge against further depreciation versus the dollar. But a decline in implied volatility suggests they aren’t expecting a repeat of the dramatic swings on Friday.

“Controlled depreciation essentially results in a gradual shift higher in the dollar-yuan range, to reflect changing external factors,” including the chance of smaller rate cuts in the US and a stronger dollar, said Ju Wang, head of greater China FX and rates strategy at BNP Paribas SA. If the greenback rallies more, “then dollar-yuan fixing will shift up later. But for now, it seems the fixing will stay here.”

While officials are showing support for the currency, the wide gap between US and Chinese interest rates and seasonal factors could still weigh, according to Xiaojia Zhi, head of research at Credit Agricole CIB Hong Kong Branch.

“The PBOC is also not encouraging a big jump in yuan depreciation expectations,” she said. “A gradual return to more flexibility to the yuan is likely as the currency could potentially see some pressures ahead.”

(Updates with chart and comments.)

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