China's Yuan Reference Rate Declines Most Since August 2010 After Deficit

China’s central bank weakened its daily fixing for the yuan by the most since August 2010 after the government reported the biggest trade deficit in at least 22 years.

The currency fell the most in seven weeks as People’s Bank of China Governor Zhou Xiaochuan said in Beijing the exchange rate is linked to the balance of payments. The nation’s trade shortfall was $31.5 billion in February, four times the previous largest deficit, according to data released on March 10 by the customs bureau. The central bank will use exchange rates and interest rates to manage the economy as Europe’s debt crisis damps global demand, it said in a statement today.

“The first three to four months, you will have a repeat of the 2008 situation where the exchange rate is flat,” said Cliff Tan, East Asia head of global currency research at Bank of Tokyo-Mitsubishi UFJ in Hong Kong. “Once the European problem moves off the front burner, risk-taking will come back and we will see a new pattern of fixing to allow a catch-up with 5 percent annual gains.”

The reference rate was set 0.33 percent lower at 6.3282 per dollar. The currency can move 0.5 percent either side of the fixing. The yuan declined 0.22 percent to 6.3247 at 11:36 a.m. in Shanghai, the biggest loss since Jan. 20, according to the China Foreign Exchange Trade System.

‘Balanced Level’

In Hong Kong’s offshore market, the yuan weakened 0.2 percent to 6.3160. Twelve-month non-deliverable forwards fell 0.3 percent to 6.3145, a 0.2 percent premium to the onshore spot rate, according to data compiled by Bloomberg.

The government will keep the exchange rate “basically stable at an appropriate and balanced level,” Wen said in the opening speech to the NPC on March 5. He announced an economic-growth target of 7.5 percent for 2012, the first time below 8 percent since 2004.

Governor Zhou said whether the yuan’s advance is ending depends on market forces of supply and demand. Fluctuations in the currency are also largely decided by the nation’s balance of payments, he said. The central bank may reduce its intervention in the market once the yuan’s exchange rate is more balanced, Zhou said at a press briefing in Beijing today.

Increasing Volatility

One-month implied volatility, a measure of expected currency swings used to price options, climbed to 2.2 percent, the most in two months. The daily trading band may be widened while the currency is moving “very close” to a “balanced level,” Xinhua News Agency reported last week, citing PBOC’s Zhou.

“When you have conditions like this where markets have elevated volatility and the external outlook isn’t that clear, the PBOC tends to fix the yuan quite randomly,” Andy Ji, a foreign-exchange strategist in Singapore at Commonwealth Bank of Australia. (CBA) “They will try to move the yuan lower. We expected exports to slow.”