MNI INTERVIEW: PBOC Yuan Defence Volatility Call: Ex-PBOC Offl

--PBOC Won't Choose Level For Yuan, But May Smooth Volatility

--Room For Policy Rates Hike Exists As Domestic Inflation Rises

     BEIJING (MNI) - The tolerance of the People's Bank of China for the yuan

testing 7.0 against the U.S. dollar will depend mainly on the speed of decline

and the depth of bearish sentiment, particularly as economic indicators start to

point lower, a former forex regulator told MNI.

     "The target of the PBOC's forex control is not to choose a level for the

market, but to prevent excess volatility of the yuan exchange rate against the

greenback," Guan Tao, former Director General of Balance of Payments at the

State Administration of Foreign Exchange (SAFE) said in an interview with MNI,

stressing that a sharp depreciation of the yuan would pressure the domestic

financial stability.

     The PBOC has been dedicated to a free float of the yuan exchange rate, but

it is also concerned any overshooting yuan depreciation could pressure

cross-border capital flow.

     "No matter whether the PBOC chooses intervention or not, it should send

clear signals and stick to the decision, considering yuan volatility around a

fixed range will encourage speculation," said Guan, now a senior researcher of

China Finance 40 Forum, a prominent China think tank.

     Guan made the comment as the USDCNY on Wednesday rose to 6.9348, the

highest level since April, 2017 and USDCNH rose to 6.9586, as the dollar index

surged as high as 96.98, due in part to a weaker euro.

     However, Guan noted that sharply bearish market sentiment was not yet

dominating, with the premium of USDCNH non-deliverable forward transactions(NDF)

at around 1.7% on Aug 13, below the 2% to 5% seen during the period of the yuan

slump between 2015 and 2016.

     --DEPRECIATION PRESSURE

     The veteran forex official admitted that the short-term depreciation of the

yuan would intensify and capital outflows would be under pressure due to

uncertainty in both domestic and external outlooks.

     But he said the PBOC has plenty of tools to stabilize excess yuan

fluctuations, adding one direct measure could be the restarting of the

counter-cyclical factor in the fixing mechanism.

     "If the PBOC decides to step into the forex market, it should take

effective action and make a blow to shorting sentiment," Guan said, adding the

reintroduction of the 20% reserve requirement on FX forward purchases has only

limited scope in curbing shorting sentiment.

     --POLICY RATES

     As USDCNY rises close to 7.0, there has been a pick-up in chatter

suggesting the PBOC may follow the Federal Reserve and hike its policy rates to

attempt and re-widen the narrowing yield spread between Chinese and U.S. bonds.

     Guan said there indeed is room for rates hikes, considering inflation rose

last month and it would pick up further this year. But he does not think any

hike would be down to yuan volatility.

     The Consumer Price Index, a main gauge of inflation, climbed to 2.1% from a

year earlier in July, faster than the 1.9% seen in June.

     "Even if the PBOC raises rates, it should not just follow the Fed,

considering the independence of our monetary policy," Guan said.

     --DOMESTIC REFORM

     Longer-term exchange rate stability will be largely a reflection of

domestic economic fundamentals, Guan said.

     "In the long term, the yuan exchange rate will be decided by economic

fundamentals, which means we should deal with the domestic problems first,

including the reform of the financial sector," he noted.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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