SHANGHAI: China’s yuan firmed on Tuesday from near 20-month lows a day earlier, as the country’s largest city moved closer to lifting stifling lockdowns and investors reconsidered the impact of US rate increases on a high-flying dollar.

After watching the yuan slump nearly 7% against the dollar since the end of March, traders said further sharp depreciation was unlikely, though the pressures that led to the drop remain.

Domestically, a gloomy economic picture made worse by COVID-induced lockdowns and mobility restrictions have weighed on the yuan, but monetary authorities have stopped short of aggressive policy easing. On Monday the People’s Bank of China (PBOC) left its medium-term lending rate unchanged.

“The PBOC appears reluctant to engage in strong and broad steps … The bank’s cautious approach is possibly a response to the yuan’s weakness and an increase in inflation,” said Matthew Ryan, senior market analyst at Ebury.

In the latest iteration of more targeted support policies, China’s state planner said Tuesday that it would strengthen support for manufacturers, the service sector and small firms to help soften the impact of COVID-19 curbs.

Yuan near 20-month low as economic gloom overshadows easing lockdowns

And offering some hope to a battered economy, the financial hub of Shanghai on Tuesday set out its clearest timetable yet for exiting a lockdown now in its seventh week, as it reported three consecutive days with no new COVID-19 cases outside quarantine zones.

But given ongoing near-term pressure on the yuan, some traders and analysts said authorities could still resort to policy tools.

“The dislocation of economic fundamentals between China and the US has been more obvious in the second quarter and there is still room for yuan depreciation in the short term.

But we can’t rule out that the central bank will resort to policy measures to ease the devaluation,“ said a trader at a Chinese bank.

Ming Ming, chief macro analyst at CITIC Securities, said that the central bank has a “rich policy toolbox” to handle exchange rate volatility, and could use policy-level regulation to rein in rapid yuan depreciation caused by a stronger dollar.

In the longer term, stabilising economic fundamentals in China and a weaker greenback could help the yuan re-emerge stronger, he said.

Expectations that the Federal Reserve will continue to raise rates to cool stubbornly persistent inflation lifted the greenback to its firmest point in 20 years on Monday.

But the currency pulled back on Tuesday as traders bet aggressive tightening could drag on longer-term growth.

The People’s Bank of China set the yuan’s daily midpoint at 6.7854 per dollar, firmer than Monday’s fix of 6.7871.

Spot yuan opened at 6.7770 per dollar and traded at 6.7794 at midday, 76 pips firmer than Monday’s late session close. The offshore yuan firmed to 6.7888 per dollar.

Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan’s value, traded at 6.8208.