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China lets yuan fall further, fuels fears of currency war

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08/12/2015 | 07:56pm CEST
File picture illustration taken in Beijing shows Chinese 100 yuan banknotes

SHANGHAI (Reuters) - China's yuan fell to a four-year low on Wednesday, slumping for a second day, after the central bank devaluation on Tuesday, and sources said the government may let the currency slide even further to help exporters.

Spot yuan in China hit a low of 6.4510 per U.S. dollar, its lowest since August 2011, after the central bank set its daily midpoint reference at 6.3306, below the level set by Tuesday's devaluation. The currency fared worse in international trade, touching 6.59 to the dollar.

The yuan has lost 3.5 percent against the U.S. dollar in China in the last two days, and around 4.8 percent in global markets.

The central bank, which had described the devaluation as a one-off step to make the yuan more responsive to market forces, on Wednesday sought to reassure financial markets that it was not embarking on a steady depreciation.

The devaluation had sparked fears of a global currency war and accusations that Beijing was unfairly supporting its exporters.

"Looking at the international and domestic economic situation, currently there is no basis for a sustained depreciation trend for the yuan," the People's Bank of China (PBOC) said.

Foreign exchange traders later said state-owned banks were selling dollars on behalf of the PBOC to restrain the yuan's fall and the spot market rate rallied strongly late in the day to close 6.3870, a rate which will influence Thursday's setting.

"Apparently, the central bank does not want the yuan to run out of control," said a trader at a European bank in Shanghai.

However, sources involved in the Chinese policy-making process said powerful voices within government were pushing for the yuan to go still lower, suggesting pressure for an overall devaluation of almost 10 percent.

Tuesday's yuan devaluation followed a run of poor economic data and resulted in the biggest one-day fall since 1994, raising market suspicions that China was embarking on a longer-term depreciation of its exchange rate that would make Chinese exports cheaper.

Data on Chinese factory activity growth and retail sales on Wednesday underlined sluggish growth in the world's second-largest economy, while fiscal expenditures jumped 24.1 percent in July, reflecting Beijing's efforts to stimulate economic activity.

China's Ministry of Commerce acknowledged on Wednesday that the depreciation would have a stimulative effect on exports, as some Chinese steel producers have already cut export prices in response to the lower yuan.

Economic growth in China has slowed markedly this year and will hit a 25-year low even if it meets its official 7.0 percent target. Some economists believe China's economy is already growing only half as fast as official data shows, or even less.

Analysts at BMI Finance Ltd in Hong Kong downgraded their year-end forecasts for the currency to 6.83, down 10 percent from pre-devaluation levels.

The currency's slide puts other Asian economies at a disadvantage also and resulted in Indonesia's rupiah and Malaysia's ringgit hitting 17-year lows on Wednesday. The Australian and New Zealand dollars also fell to six-year lows.

Indonesia's central bank pinned the rupiah's fall directly on the yuan devaluation and said it would step into the foreign exchange and bond markets to curb volatility.

STOCKS FALL AGAIN AFTER YUAN SLIDE

Stocks fell again worldwide in the wake of the yuan devaluation as exporters to China feared a loss of competitiveness.

An MSCI index of stocks on major world markets lost 1.0 percent. Companies with notable exposure to China, including German automaker BMW and U.S. luxury goods maker Coach, lost 3.7 percent and 5.4 percent respectively.

Investors sought safety in top-rated government bonds, driving yields on German two-year bonds to a record low and pushing U.S. Treasury yields down, with some analysts saying a long-awaited Federal Reserve interest rate rise may now be delayed.

Trading in money markets showed investors are reducing expectations for a Fed interest rate increase in September due to concerns about global disinflation pressures resulting from China's moves.

"Volatility is picking up and it’s causing turmoil, it’s pushing bond yields lower and it’s casting more doubt on the Fed," said Axel Merk, president and chief investment officer of Palo Alto, California-based Merk Investments.

PLAYING TO THE IMF?

The International Monetary Fund said China's move to make the yuan more responsive to market forces appeared to be a welcome step and that Beijing should aim for an effectively floating exchange rate within two to three years.

Beijing has been lobbying the IMF to include the yuan in its basket of reserve currencies known as Special Drawing Rights, which it uses to lend to sovereign borrowers, which would enable more international use of the yuan.

"Greater exchange rate flexibility is important for China as it strives to give market forces a decisive role in the economy and is rapidly integrating into global financial markets," an IMF spokesperson said.

William Dudley, head of the New York Federal Reserve, also said an adjustment to the yuan was probably appropriate if the Chinese economy was weaker than the authorities had expected.

On a trade-weighted basis, China's yuan has been rising in recent years in part because of its peg to the U.S. dollar. The yuan has gained more than 14 percent over the last year when factoring in inflation, according to data from the Bank for International Settlements, making its exports less competitive.

However, the devaluation was decried by U.S. lawmakers from both parties on Tuesday as a grab for an unfair export advantage and could set the stage for testy talks when Chinese President Xi Jinping visits Washington D.C. next month, given acrimony over issues ranging from cyber security to Beijing's territorial ambitions in the South China Sea.

(Additional reporting by Samuel Shen in SHANGHAI and Jason Subler in BEIJING; Writing by Will Waterman, Nigel Stephenson and David Gaffen; Editing by Mike Collett-White and Clive McKeef)

By Pete Sweeney and Lu Jianxin

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