China's central bank has intervened in currency markets to halt the slide of the yuan against the United States dollar and to curb the huge flows of capital out of the country.
Although the yuan pared its gain yesterday, the currency chalked up its largest weekly rise in recent months.
Experts say the suspected intervention by the People's Bank of China (PBOC) is likely to offer only temporary relief, and they tip the yuan to depreciate further over the year as more Chinese try to get their cash out. This will in turn put the regulator's priorities at odds with the long-term aim of liberalising the capital markets.
The yuan was trading at around 6.8277 against the greenback in the offshore market yesterday following a topsy turvy week.
It was a much-needed cooldown for Chinese regulators after the offshore yuan shot above 6.97 this week amid persistent short-selling. The PBOC is believed to have responded by significantly ramping up the offshore interbank borrowing rates throughout this week to make short-selling on the currency too expensive to carry out, a move that led to many short-sellers being squeezed.
Oanda senior market analyst Jeffrey Halley noted the effect: "China's central bank has engineered the mother of all funding squeezes on the offshore market."
Mr Halley said the central bank's intervention has deferred the prospect of the yuan falling to 7 against the US dollar, at least until the greenback itself rebounds or funding normalises.
Yesterday morning, the PBOC also raised the yuan exchange rate against the US dollar by 0.9 per cent - the biggest single-day increase since 2005 - to a fixing of 6.8668.
China's central bank has engineered the mother of all funding squeezes on the offshore market. ''
OANDA SENIOR MARKET ANALYST JEFFREY HALLEY
Against this backdrop, the onshore yuan sat at 6.9178 against the US dollar yesterday. Its retreat was a result of increasing US dollar demand by local companies, a trader at a Chinese bank told Reuters.
At the heart of these interventions is Beijing's struggle to curb capital flight, which is bound to quicken if the yuan sags further.
"It's probably more of a response to concerns of an accelerated rate of outflow if the yuan is allowed to weaken past 7 per the dollar," UOB's currency team said in a report yesterday.
But further currency market volatility is to be expected, with sentiment shaken by US President-elect Donald Trump's pledge to label China a currency manipulator on his first day of office on Jan 20.
"In all, we foresee depreciation pressures on the yuan to return eventually and send the US dollar-yuan towards 7.16 by the end of 2017," the team added.
KGI Securities Singapore trading strategist Nicholas Teo said the latest intervention was counterproductive to the Chinese regulators' attempt to liberalise the country's capital and financial markets.
"Loosening of capital controls at this juncture is out of the question, especially when risk of capital flight is at best reduced or pushed back, not eliminated," UOB noted.