MNI EXCLUSIVE: PBOC To Permit Broader Yuan Band, 7.2 Key Level

--The PBOC Will Permit A Wider Band, But Will Act Against Volatility, Sources

Say

--Recent Depreciation Not In Line With Fundamentals

     BEIJING(MNI) - The People's Bank of China will permit a wider trading band

in the yuan, which has come under pressure as tensions rise with the U.S. over

Hong Kong and trade, but it will act to prevent excessive volatility, sources

familiar with foreign exchange operations told MNI, with one pointing to 7.2 to

the dollar as a key level in the short term.

     While the yuan could trade between 6.8 and 7.4 in 2020, it is likely to end

the year having depreciated from 2019's closing price of 6.9662, one source

said.

     Central bank fixings indicate the PBOC does not want a sharp fall or for

expectations to build of a one-way trade for the market, the source said, noting

the call for a stable exchange rate, at an appropriate and balanced level, in

Premier Li Keqiang's latest working report.

     While the yuan could trade as low as 7.2 to the dollar in the short term if

China-U.S. tensions intensify, the central bank will watch that level closely,

another source said, adding that it was likely the currency would rally back to

7.1 or beyond.

     --FUNDAMENTALS

     The depreciation of recent sessions is not in line with economic

fundamentals, and China is not seeking to weaken its currency to shore up

exports, sources said, noting that overseas demand had fallen so sharply that

the level of the yuan was not likely to make much difference. They also referred

to increasing concern in Beijing over capital outflows, both from the domestic

economy and from Hong Kong.

     The onshore CNY rate has weakened by 2.86% against the greenback this year,

compared with a 1.46% depreciation for the whole of last year, when the trading

range was 5,165 pips. This, sources said, was set to be exceeded in 2020, given

political and economic uncertainty.

     But recent PBOC yuan fixings have deviated from expectations, settling at

7.1277 today compared to 7.1322 foreseen in a Bloomberg survey. Wednesday's

fixing of 7.1092 was stronger than the expected 7.1144.

     They came after the yuan began to weaken at the beginning of May, with the

onshore CNY rate losing 1,028 pips by May 27. Yesterday, the currency touched

its weakest level since Sept. 3 last year, at 7.1765 against the dollar onshore

and 7.1953 for the offshore rate.

     The PBOC has many tools to stabilise the forex market, another source said,

adding that it could restore the counter-cyclical factor to its daily fixing

formation, tighten offshore liquidity or use window guidance to prop up the spot

or forward yuan. A weaker-than-expected stimulus package announced by the

National People's Congress last week and expectations of a fall in this month's

trade surplus have added to pressure on the currency, the source said.

     Other policies will also buoy the yuan, including plans for a fund to

assist exports, paid for by special Treasury bonds, and continuing progress

towards promoting international use of the currency, one of the sources said.

     --CONCERN OVER OUTFLOWS

     A key motivation for the PBOC in avoiding any sharp depreciation is concern

that it might spark large capital outflows, as occurred in 2016 in the wake of

the surprise devaluation of August 2015, a third source said. Inflows of hot

money as China opens up its financial sector heighten that risk, the source

said, noting that if the PBOC were to allow momentum for a weaker currency to

develop, it would be expensive to reverse.

     Officials are also increasingly concerned by outflows from Hong Kong, with

Beijing approving on Thursday a proposal to bring the territory under its

national security law. A collapse in market liquidity would force up interest

rates, unless the authorities abandoned their dollar peg, potentially bursting

Hong Kong's huge property bubble, the third source said.

     The second source said Hong Kong had sufficient foreign reserves to cope,

noting that the territory was still an attractive hub for investing in the

mainland, although it is possible its status as a global financial centre could

be tarnished. Liquidity levels in the territory must be monitored, the source

said.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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