MNI Insight: PBOC Yuan Support May Fade If U.S. Plays Tough

--Officials See Yuan Depreciation As Offsetting Tariff Impacts

--PBOC May Sell Forex Reserves If Yuan Weakness Persists

     BEIJING (MNI) - The People's Bank of China will prop up the yuan at least

until the U.S. goes ahead with its threat to impose 25% tariffs on another $200

billion worth of Chinese goods, and the currency is unlikely to breach 7 to the

dollar this year, MNI has learned from officials and government advisors.

     The yuan has depreciated more than 9% since mid-April, in a development

officials have seen as helping to counteract the effect of any U.S. measures

against the country's exports. But Beijing does not want to further provoke

Washington with an excessive devaluation, and the PBOC moved to support the

currency last Friday, announcing that it had reintroduced the so-called

"counter-cyclical factor" into its daily fixing formula since August.

     "There are two reasons for the reintroduction -- to curb the rising market

sentiment shorting the yuan and to show the U.S that China does not want any

sharp weakness of its currency," a source familiar with the PBOC's operations

told MNI, mentioning President Donald Trump's accusation last week that China

was manipulating its exchange rate.

     --YUAN SUPPORT MAY BE TEMPORARY

     Another senior official, though, indicated that China's authorities, while

prepared to step in to bolster the currency when prudent, might be less willing

to do so if the U.S. plays tough on trade.

     "The current situation (of the yuan exchange rate) is not bad ... the

bottom line of the yuan's depreciation against the greenback is to offset the

side effects of the U.S. tariffs," a high-ranking advisor to the central

government said during a recent closed door meeting.

     MNI had cited sources Aug.7 that the central bank would reintroduce the

counter-cylical factor if the yuan fell closer to the 7 level. (See Mainwire on

Aug. 7 at 7:20 a.m. London time: MNI SOURCES: PBOC May Vigorously Defend Yuan if

USDCNY Nears 7) It traded at 6.93 by mid-month, before easing to 6.83 by Aug.

29.

     Use of the factor adds uncertainty to the currency market, as the PBOC has

not explained how it is calculated, but when it was first employed, from May 26,

2017 to Jan. 19, 2018, the yuan jumped 6.7% against the dollar, reversing a 7%

depreciation in 2016.

     "The reintroduction of the factor indicates the PBOC has decided to curb

the sharp depreciation since the middle of June, and the 7 level in USDCNY won't

be broken unless the dollar index sees a big rise or the trade war escalates

further, " the source familiar with PBOC operations said, noting that the

central bank could also sell forex reserves if yuan weakness persists.

     --RESERVE SELLING

     The PBOC spent over $800 billion of forex reserves to boost the yuan from

2015 to 2016 when the dollar surged 12% against the currency, but the bank's

stocks of reserves have remained stable at around $3.1 trillion this year, and

grew from May to July.

     Now that the PBOC has indicated to the market that it wants to stabilise

the yuan, by reintroducing the counter-cyclical factor, it may be forced to

resort to reserve-selling if the currency continues to weaken, Yu Yongding,

formerly a PBOC Monetary Policy Committee member, told MNI on Monday.

     "Given that the PBOC has moved to intervene, it should be prepared to use

reserves," Yu said, although he added that, in his personal opinion, forex

intervention was generally counter-productive. "If it uses reserves to stabilize

the yuan exchange rate, the loss will outweigh the gain."

     A person close to the central bank confirmed that direct intervention could

come if the introduction of the factor failed to buoy the yuan.

     "If the situation goes against the PBOC's intention, the regulator may

directly step in," the source said, arguing that the use of the factor did not

by itself constitute direct intervention in the market, as it only affected the

fixing price.

     This has jumped 0.64% in the three days since the PBOC revealed late on

Friday that it was using the counter-cyclical factor, while the yuan has

strengthened by about 0.9% against the dollar in market.

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

[TOPICS: MT$$$$,MX$$$$]