The offshore yuan slid to the weakest level in more than two years after the central bank cut interest rates for the second time in three months.

The move to join global counterparts with more easing reflects the People’s Bank of China’s concern over an economy pressured by a property slump, tighter controls over local government debt and capital outflows. Manufacturing contracted for a second straight month in February, data indicated after Saturday’s reduction in borrowing costs.

“It’s pretty clear a rate cut is negative for the currency,” Dariusz Kowalczyk, a strategist at Credit Agricole CIB in Hong Kong, said in a March 1 phone interview. “Stimulating the economy has taken precedence over stabilizing the currency. They’ll allow more depreciation, and it makes sense because the dollar is so strong.”

The offshore yuan declined 0.18 percent to 6.2986 a dollar as of 8:55 a.m. in Hong Kong Monday, according to data compiled by Bloomberg. It touched 6.3021, the weakest since October 2012. Onshore trading will begin at 9:30 a.m. in Shanghai. The dollar has strengthened against all 24 emerging-market currencies in the past six months.

The PBOC lowered the one-year deposit rate by 25 basis points, or 0.25 percentage point, to 2.5 percent and the one-year lending rate by 25 basis points to 5.35 percent effective March 1, according to a statement on its website. It increased the deposit rate ceiling to 1.3 times from 1.2, meaning lenders can pay a larger margin over the benchmark. This effectively lowers the maximum deposit rate by 5 basis points to 3.25 percent, Goldman Sachs Group Inc. economists Yu Song, MK Tang and Maggie Wei wrote in a Feb. 28 note.

Market Role

The higher deposit-rate ceiling is a step toward market-oriented interest rates, Ma Jun, chief economist at the PBOC’s research bureau, was cited as saying in a Feb. 28 China Business News report. Lowering interest rates amid slowing inflation and pressure on the economy will keep real interest rates stable and maintain neutral and prudent monetary policy, Ma said.

The cost of one-year interest-rate swaps, the fixed payment to receive the floating seven-day repurchase rate, fell three basis points to 3.35 percent in Shanghai.

“We expect further policy loosening in the coming months,” the Goldman economists wrote in the note. “The next move is likely to be a reserve-requirement-ratio cut, likely in the second half, but a cut toward the end of the first quarter cannot be ruled out.”

Weakening Economy

The official manufacturing Purchasing Managers’ Index was 49.9 last month, compared with January’s 49.8, the statistics bureau and the China Federation of Logistics and Purchasing reported Sunday. Numbers below 50 signal contraction. China reduced the amount of reserves that banks have to keep on hand earlier this month, after cutting its benchmark interest rate in November for the first time in two years.

Saturday’s rate cut will likely add to dollar demand against the Chinese currency, which is being driven largely by signs of yuan overvaluation, HSBC Holdings Plc analysts including chief China economist Qu Hongbin wrote in a note.

“We maintain our view that China will not deliberately weaken its currency as it would go against the authorities’ commitment to economic rebalancing and structural reforms,” the HSBC economists said. “The size of the Chinese economy also means a large, deliberate yuan devaluation would be disruptive to global trade flows and international relations.”

The PBOC keeps the yuan within 2 percent of its daily reference rate, which has been lowered by 0.5 percent this year. The Shanghai spot rate’s gap against the fixing is near the weak end of its permitted trading range, closing within 0.03 percent of the limit on each of the last five trading days.

“Instead of interest rates, investors should focus on the recent change in foreign-exchange policy,” Sean Yokota, the Singapore-based head of Asian strategy at Skandinaviska Enskilda Banken AB, said in a March 1 note. “We are starting to see the central bank’s behavior shifting to allow for a weaker yuan.”


Source: http://www.bloomberg.com/news/articles/2015-03-02/yuan-drops-to-two-year-low-in-hong-kong-after-pboc-rate-cut
 

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