By Steven Russolillo and Joanne Chiu
China's yuan slid to its weakest level of the year, nearing the symbolic level of 7 per dollar, after President Trump threatened to impose more tariffs on Chinese imports.
The prospect that tariffs could be extended to essentially all Chinese imports has further clouded China's efforts to manage its currency. A weaker yuan makes it cheaper for U.S. buyers to purchase Chinese goods, helping offset the impact of higher tariffs. But China doesn't want to prompt an exodus of capital, which in turn could prompt further currency depreciation.
Policy makers have defended the 7 level at various points in recent years. Economists and analysts said Beijing might now permit the currency to cross that threshold, to help offset economic pressures, and a small devaluation would have manageable effects. But they said it would still be unlikely to tolerate a sharp and potentially destabilizing selloff.
"As we have learned in the past, fundamentals alone are insufficient for the Chinese yuan to break 7," said Jason Daw, head of emerging-markets strategy at Société Générale. "Policy makers have the tools to stop it and, put simply, it is their choice what happens."
While the Chinese currency hasn't breached that level in a decade, he said the odds of the yuan breaking 7 in the next month or two has increased substantially.
On Friday, the yuan depreciated beyond 6.9 to the U.S. dollar in the offshore market, hitting 6.9769--its weakest since November. The onshore yuan traded 0.6% weaker at 6.9360 a dollar, registering its biggest single-day drop in 2 1/2 months.
Earlier on Friday, Beijing guided the daily midpoint for onshore trading to 6.8996 a dollar, slightly weaker than the previous day. Authorities fix a daily midpoint, based partly on the previous close, and let the yuan trade as much as 2 percentage points above or below that level.
China's central bank hasn't set a midpoint for yuan trading weaker than 6.9 since December.
The worry is that a weaker yuan could reverberate among Chinese residents and companies, leading them to send money offshore. In 2015 and early 2016, a sharp depreciation prompted such moves.
"I don't think Beijing would use a massive depreciation of the yuan as a tool to offset the negative impact from an escalating trade war," said Larry Hu, the Hong Kong-based head of greater China economics at Macquarie. "It's a double-edged sword, as a significantly weaker yuan is going to hurt investment sentiment and cause capital outflows."
Likewise, Tao Wang, an economist at UBS, said: "We think the government will still tightly manage the Chinese yuan to avoid any significant depreciation."
Earlier this week, the Federal Reserve cut interest rates for the first time since the financial crisis. That move, in isolation, could have taken some pressure off the yuan. Instead, the latest tariff threat has once again whipsawed the Chinese currency.
China's economic growth has decelerated to its slowest pace in decades, hurt by the trade conflict and businesses holding back from large-scale investments due to the uncertain environment. The Chinese economy grew by 6.2% in the second quarter, slower than the 6.3% year-over-year rate forecast by economists.
Mr. Hu at Macquarie said Chinese policy makers could be forced to increase stimulus later this year to bail out the economy.
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