China's yuan softens as central bank hints at preference for slower gains

SHANGHAI: China's yuan softened on Wednesday, continuing its walk back from a strong rally early in the week, after the country's central bank appeared to signal a preference for a more moderate pace of appreciation.

The yuan shot up 1% against the US dollar on Monday, building on a near 7% rise in 2020, and looked set to add to gains on Tuesday before state banks were seen buying dollars in the onshore spot market to rein in the local currency's rally.

On Tuesday evening, the People's Bank of China (PBOC) announced it would raise its macro prudential adjustment coefficient for domestic firms making overseas loans. Wei He, an analyst at research firm Gavekal in Beijing, called the announcement "a classic piece of indirect currency intervention."

"In theory, the rule change could increase buying of foreign currency and thus offset some appreciation pressure.

But since the mechanism is indirect and slow-acting, the market effect comes mostly through the central bank signaling its preferences," he said, adding that small interventions "are more likely to slow than stop currency gains."

Wednesday's weaker yuan came despite a stronger fixing of the official midpoint of the currency's daily trading band . The PBOC fixed the rate at 6.4604 per dollar prior to the market open on Wednesday, its firmest level since June 20, 2018, but slightly weaker than expected.

In spot trading, the yuan opened at 6.4337 per dollar and was changing hands at 6.4594 at midday, 44 pips weaker than Tuesday's late session close.

The offshore yuan also weakened to trade at 6.4429.

Despite the pull-back from Monday's gains, the yuan remains up more than 1% against the dollar for the week, and traders say they expect its steady march upward to resume.

"Before Spring Festival, there's still likely room for appreciation. Now feels like an appropriate opportunity to enter the market," said a trader at a Chinese bank.

China's week-long Spring Festival holiday to celebrate the Lunar New Year begins on Feb. 11.

The yuan was boosted last year by a widening yield advantage in Chinese debt over other developed markets and the economy's rapid recovery from the COVID-19 pandemic, while the dollar has been hobbled by expectations the United States would announce more stimulus programmes.

On Wednesday, a private sector survey showed China's services sector activity continued to expand in December, albeit at a slower pace amid sporadic coronavirus outbreaks.

Offshore one-year non-deliverable forwards contracts (NDFs), watched as a gauge of market expectations of the yuan's value, traded at 6.5855 on Wednesday.