MNI SOURCES: Yuan May Weaken Vs Basket, Gain Vs Dollar

The yuan should weaken against its trade-weighted basket even as it appreciates against the sliding U.S. dollar, sources familiar with forex policy told MNI, noting that the People's Bank of China would act to prevent any sharp rally and could even adopt a more cautious approach to further exchange rate liberalisation in coming years.

Despite a renewed push to promote the international use of the yuan, Chinese authorities will still choose a competitive exchange rate which encourages exports and supports growth over currency strength, one source said.

Another noted that dollar weakness had been the main recent driver in USDCNY, although investor concerns over both relations with Washington and over retail and private investment data which may indicate China's economy's second-quarter rebound is losing momentum are also restraining bids for the Chinese currency.

The yuan will "softly peg" the weakening dollar, the second source said, although cautioning that it was too early to declare a bearish trend in the greenback given a weak European economy.

SCENARIOS

USDCNY closed at 6.9103 to the dollar at 4 pm Beijing time Wednesday, an appreciation of 3.6% since May 18, and could strengthen to as much as 6.7-6.8 on the back of the Chinese economy's superior performance and interest rate spreads, a third source said. On the other hand, a resurgence in U.S.-China tensions could send it to 7.2-7.3.

A desire to avoid excessive currency strength against a backdrop of domestic and external uncertainty could prompt the PBOC to be more cautious in increasing the flexibility of the yuan formation mechanism and improving its convertibility over the next few years, the third source said.

Risks in China's property markets, local government debt and shadow banking sector carry the danger of capital outflows should controls be loosened, the source said. The international trade environment could continue to deteriorate and Covid-19 could tip the global economy into a long recession, he said.

Wednesday's yuan close in Beijing took the currency to its strongest against the greenback since Jan. 22 and compared to Tuesday's 6.9257 when the dollar index hit a two-year low. The PBOC set the CNY fixing price today at 6.9168, also the strongest since the end of January.

CNY's rally since May 18 was outpaced by an 8.3% drop in the dollar index, and EURUSD has surged by 10.8% in the same period. Meanwhile, the yuan depreciated by about 1.6% against a basket of currencies from May 15 to Aug. 14, according to the CFETS RMB Index of the currencies of 24 of China's trading partners. The daily fixing price has risen by 3% since the end of May.