China's central bank takes measures to slow the yuan's fall

China's central bank has reduced the amount of foreign currency that banks must hold in reserve in an attempt to support the country's rapidly weakening currency.

The yuan is now trading at almost its lowest level in two years. In the offshore market, its price has reached 6.94 per U.S. dollar. As a result, according to FactSet, its annual decline against the dollar was 8.4 percent.

On Monday, the People's Bank of China said it would lower its reserve requirement rate for foreign currency by 2 percentage points to 6% from September 15. According to analysts, it will bring about $19 billion into the country, meaning Chinese banks will no longer have to sell yuan to buy that amount of foreign currency.

Zhiwei Zhang, president and chief economist at Pinpoint Asset Management, said China's central bank does not want to stand by and continue to watch the yuan fall, as evidenced by its decision to cut the currency reserve ratio.

He also said that the Chinese economy is currently experiencing bad times, so the central bank may try to lower the yuan exchange rate. This measure could boost exports. But these actions show that the People's Bank of China is not willing to put up with a sharp depreciation of the yuan against the U.S. dollar.

This is the second reduction in reserve requirements this year. The first reduction was in April and amounted to 1 percentage point. At that time the yuan was going through a period of weakening. Francis Cheung, an analyst at OCBC Bank, believes that the latest reduction will not have a significant impact on the supply of dollars in China.

And the measure appears to have been effective. After the announcement by the People's Bank of China at 5 p.m. Beijing time, the exchange rate fell from 6.95 yuan to 6.94 yuan per dollar in a few minutes.

But not everyone sees such measures as successful in the long term. Becky Liu, head of China macroeconomic strategy at Standard Chartered, said such a move couldn't stop the yuan's rapid depreciation, despite the larger-than-expected rate cut. In her view, divergence in monetary policy between China and the U.S. and economic pressure from China's persistent zero-rate Covid policy could lead to a further weakening of the yuan.

The U.S. Federal Reserve has waged an aggressive campaign to raise interest rates this year, raising rates by three-quarters of a percentage point in June and July. The benchmark federal funds rate now stands at 2.25-2.50%, up from 0%-0.25% at the beginning of the year. Many economists believe the hike was not the last and the Fed will continue to raise rates at the same pace. The Fed's policy caused the dollar to rise sharply against other currencies. At the same time, the Bank of China chose to go in a different direction — two key interest rates were cut in August. 

Mr. Zhang of Pinpoint Asset Management said that China may have taken such measures in anticipation of a 75 basis point Fed interest rate hike. By doing so, it would be able to make up the difference in interest rates between countries and avoid capital outflows.

According to the Bank for International Settlements, the real effective exchange rate, which takes inflation into account when measuring the dollar's strength, has surpassed the previous peak reached two decades ago.

China's central bank officials told a news conference Monday that the country is capable of strengthening its currency and that fluctuations in the yuan are normal.