SHANGHAI: China's yuan weakened to its lowest in nearly two weeks against the US dollar on Wednesday, following changes to the central bank's midpoint fixing mechanism.
The People's Bank of China (PBOC) took a step to loosen control over the yuan exchange rate on Tuesday, reflecting confidence that depreciation pressure on the currency had eased and it would allow market forces to have greater sway.
Sources familiar with the matter said the PBOC had told banks that contribute mid-point estimates they could adjust the "counter-cyclical factor" by themselves, effectively allowing them to minimise its influence on their exchange rate contributions.
The "X" factor was introduced last year to reduce volatility in the renminbi after the Chinese currency lost around 6.5 percent in 2016.
Prior to market opening on Wednesday, the PBOC lowered its official yuan midpoint to the weakest level in nearly two weeks to 6.5207 per dollar.
Wednesday's official midpoint was 239 pips, or 0.37 percent, softer than the previous fix of 6.4968 on Tuesday and was the weakest since Dec. 29, 2017.
Traders confirmed the fixing matched their models, which neutralised the effect of the "X" factor.
In the spot market, the onshore yuan opened at 6.5360 per dollar and weakened to a low of 6.5385 per dollar at one point in morning trade, the softest level since Dec. 28, 2017.
As of midday, the spot yuan rate was changing hands at 6.5218 per dollar, 67 pips firmer than the previous late session close but 0.02 percent weaker than the midpoint.
Its offshore counterpart also eased to a two-week low of 6.5450 per dollar in morning trade before paring the losses. It settled at 6.5277 per dollar as of midday, 0.09 percent weaker than the onshore spot.
A trader at a foreign bank in Shanghai said the adjustment in the fixing mechanism triggered losses in the yuan on Tuesday afternoon and continued on Wednesday morning, but added that the move was unlikely to reignite strong depreciation expectations in the yuan.
"This policy shift is a sign of strength and confidence, but in the near term, we should expect a few hiccups on the way to a stronger yuan," Stephen Innes, head of trading for Asia Pacific at OANDA said in a note on Wednesday.
Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong, said the yuan is likely to pull back to around 6.55 per dollar and see two-way volatility around 6.6 in the near term.
"In the short term, the adjustment was to suppress the appreciation sentiment to allow the yuan to weaken back to 6.55 per dollar...(the central bank) does not want the yuan to strengthen too fast," Cheung said.
He expects the yuan to trade in a range between 6.5 and 6.7 per dollar in the first half of this year.
The Thomson Reuters/HKEX Global CNH index, which tracks the offshore yuan against a basket of currencies on a daily basis, stood at 95.55, weaker than the previous day's 95.66.
The global dollar index fell to 92.441 from the previous close of 92.528.
Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan's value, traded at 6.6685, -2.22 percent away from the midpoint.
One-year NDFs are settled against the midpoint, not the spot rate.