China is pulling out all the stops to defend the yuan as its tightly controlled currency teeters dangerously close to the edge of its politically sensitive trading band against the dollar. This week, the central bank set its daily reference rate higher than analysts had expected—its most aggressive move since April—just as the offshore yuan flirted with historic lows.
State banks have also curtailed yuan lending in Hong Kong, hiking the cost of short positions and complicating the lives of bearish speculators. These manoeuvres underscore Beijing’s unwillingness to relinquish control, even as its strategy comes under strain from slowing domestic growth, tariff threats from the United States, and the fallout of its interest rate cuts. The looming fear? The answer is clear: a chaotic capital flight that could trigger a fire sale of yuan-denominated assets and derail an already lacklustre recovery.
But there’s a cost to this stubborn intervention. Liquidity issues loom as the yuan edges closer to its trading limits, and the support measures have propelled the currency to a two-year high against a basket of peers. This development could squeeze Chinese exporters who are already facing waning global demand.
On Wednesday, the PBOC set the dollar-yuan fixing at 7.1887, a striking 1,528 pips above Bloomberg’s median analyst estimate—the widest margin since April. The market viewed this as an unmistakable signal from Beijing to steer the currency in its desired direction. The yuan’s onshore exchange rate can deviate by 2% from the daily fixing, a key tool for managing expectations.
Still, traders have tested the limits, pushing the yuan close to the weaker end of its band. Similar moves in the past have disrupted the derivatives market, underscoring the challenges Beijing faces in controlling the currency.
Adding to the drama, yuan borrowing costs in Hong Kong have spiked, reflecting expectations of more PBOC intervention. Overnight interbank rates soared to 8.1%—the highest since 2021. The one-month rate climbed for the third straight day to 4.45%, its highest since April.
Meanwhile, state banks have been actively selling dollars against the yuan near key levels, effectively putting a floor under the currency.
The central bank’s commitment to curbing market disruption was further reinforced in its latest monetary policy statement, vowing to crack down on speculative behaviour and prevent excessive deviations in exchange rates. Local media outlet Yicai reported that the PBOC plans to increase yuan bill auctions in Hong Kong, a move aimed at soaking up offshore liquidity and making short-selling the yuan even more costly.
Yet analysts broadly expect the yuan to weaken further this year, given China’s struggling economy and the spectre of tariffs from US President-elect Donald Trump.
Even if some tariff risks are already priced in, an additional 10% tariff from Trump on Inauguration Day could send the dollar-yuan exchange rate into uncharted territory. For all its efforts, Beijing’s grip on the yuan faces mounting challenges, with the risks of overreach and unintended consequences growing ever larger.