Views the yuan will drop further are gaining ground as signs emerge that China's central bank is preparing interest rates cuts to prop up a faltering economy.
The yuan has sharply weakened in recent weeks as China's economy slowed due to its zero-COVID lockdowns and as interest rates start rising in the U.S. The currency slid 5% since mid-April, touching 6.74 yuan per dollar in the Shanghai market on Tuesday, an 18-month low.
Furthermore, the country's central bank, the People's Bank of China, has set the yuan's reference rate in the weaker direction for three consecutive sessions through Tuesday, demonstrating it will tolerate the currency depreciating by a certain amount.
But the yuan may weaken even more. The PBOC appears to be laying groundwork for a rate cut now that it is urging commercial banks to cut deposit rates.
Last month, the Industrial and Commercial Bank of China, a major state-owned lender, cut two- and three-year deposit rates by 10 basis points to 2.6% and 3.25% for large accounts.
The weighted average rate for all new deposits nationwide stood at 2.37% for the period between April 25 and May 1, according to a report released Monday by the central bank, marking a 0.1-point drop from the previous week.
These cuts were triggered by the PBOC, which has urged commercial banks to lower deposit rates. Although nonbinding, a central bank's report issued on Monday offered incentives to lower deposit rates. Banks that fall in line will score points in macro prudential assessments, which evaluate lender health to maintain stability in the financial system.
The Chinese economy, which has slowed down largely due to Shanghai's COVID lockdown that began at the end of March, needs a shot in the arm. The restrictions disrupted logistics, and domestic demand has slumped.
The central bank aims to prop up the economy by boosting bank financing. By first lowering deposit rates, commercial banks lower their costs, creating a better environment for lending.
On April 25, the PBOC lowered the reserve requirement ratio for commercial banks by 0.25 to 0.5 percentage points, a move that also lowers costs for banks. It was the first time the reserve ratio has been cut since December, and the average rate for all banks fell to 8.1%, a low not seen since July 2006.
In addition, the central bank has returned 800 billion yuan ($119 billion) in profit to the central government this year, money that will be directed to companies and other entities, meaning the same amount of money is being supplied to the market. This would be equivalent to lowering the reserve ratio by 0.4 point, according to the PBOC.
After noting these cost-cutting measures for banks, many in the market believe that the PBOC is setting the stage to cut the loan prime rate, which functions as China's de facto policy rate.
"A rate cut will occur in May or June," said Lu Ting, chief China economist for Japanese brokerage Nomura Holdings.
One lingering concern is the risk that a sharply weaker yuan will trigger capital flight. If China goes in the reverse direction of the rate hikes taking place in the U.S. and Europe, it may create pressure on international investors to sell off Chinese government bonds and other assets. It is believed that the PBOC is monitoring the yuan's movement closely in the run-up to its monetary decision. - Nikkei-