BEIJING—China’s currency fell further Wednesday following a surprise change in its exchange rate mechanism that rattled global markets and threatens to fan trade tensions with the United States and Europe.
The central bank said the yuan’s 1.9 percent devaluation Tuesday against the U.S. dollar, which was its biggest one-day fall in a decade, was due to changes aimed at making the tightly controlled currency more market-oriented. That raised the prospect of still more declines, which would help struggling Chinese exporters at the expense of foreign competitors and might shore up flagging economic growth.
On Wednesday, the yuan dropped another 1.6 percent. In theory, it could drop 2 percent every day given it can trade 2 percent around a rate that is set based on the previous day’s closing value.
Until now, China has set the yuan’s value each day based on a basket of currencies that is believed to be dominated by the U.S. dollar. That meant the yuan rose as the dollar jumped over the past year, hurting its exporters and raising the threat of politically dangerous job losses. Exports in July plummeted by an unexpectedly steep 8.3 percent from a year earlier.
The People’s Bank of China promised Tuesday to keep the exchange rate “basically stable,” but Wednesday’s decline prompted suggestions the yuan is likely to fall further.
The yuan is likely to see “continued strong influence” from the central bank, with Tuesday’s change “probably marking the start of an engineered depreciation,” said Mizuho Bank in a report.
Many economists cautioned against seeing Beijing’s move mainly as an effort to benefit its exporters. They note that China’s currency, left to market forces alone, would have declined in value in recent months.
The depreciation “will not change the gloomy picture of global demand,” said Vincent Chan of Credit Suisse in a report. “The 2 percent devaluation cannot provide any meaningful help, but it caught the market by surprise.”
U.S. stocks tumbled Tuesday, with the Dow Jones industrial average closing down 212 points.
China becomes the third major trader to take actions that lower the value of its currency. Initiatives by Japan and the European Union over the past two years depressed the yen and euro by a wider margin than this week’s decline in the yuan.
The yuan, also known as the renminbi, is allowed to fluctuate in a band 2 percent above or below a rate set by the People’s Bank of China based on its currency basket.
The bank said that starting Tuesday, the daily target will be based on the yuan’s closing the previous day and information from traders about supply and demand for the currency.
The change presented a dilemma for China’s trading partners, who have called repeatedly for Beijing to let market forces set its exchange rate but don’t want to see the yuan weaken.
It sparked complaints in Washington, where members of Congress have long complained Beijing manipulates its currency to gain a trade advantage.
“For years, China has rigged the rules and played games with its currency,” said U.S. Sen. Chuck Schumer. “Rather than changing their ways, the Chinese government seems to be doubling down.”
The U.S. Treasury Department’s response was more measured.
“China has indicated that the changes announced today are another step in its move to a more market-determined exchange rate,” a department statement said.
The International Monetary Fund said the change “appears a welcome step” to give market forces a bigger role.
“The exact impact will depend on how the new mechanism is implemented in practice,” said an IMF statement. “We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years.”
The IMF said the latest change would have no effect on the decision about whether to add the yuan to the dollar, the euro, the yen and the British pound in the basket of currencies used to set the value of the Fund’s in-house currency, called Special Drawing Rights. The IMF staff recommended last week that China wait until at least October 2016 to join. The Fund’s board is due to consider that recommendation in October.
China’s economic growth has slowed to an annual rate of just 7 percent, which is healthy for most countries but far below the previous decade’s double-digit pace.
The Federal Reserve is expected to boost the short-term interest rate it controls later this year. A rate hike would likely raise the value of the dollar, which has already jumped about 14 percent in value in the past 12 months against a basket of foreign currencies.
The rising dollar has hurt U.S. exporters by making their goods costlier abroad, and China’s devaluation could further complicate the Fed’s decision on when to raise rates. By making Chinese goods comparatively cheaper in the United States, a weaker yuan would push already-low U.S. inflation even lower.
The Fed wants to be “reasonably confident” that inflation is returning to its 2 percent target before raising rates. Inflation has risen just 1.3 percent in the past 12 months.
Michael Feroli, an economist at JPMorgan Chase, suggested the dollar’s rise poses a concern for some Fed officials, known as doves, who have been reluctant to raise rates. Should the U.S. economy stumble in the coming weeks, “dollar strength would only further embolden the doves at the next meeting” in September, Feroli said.
Still, Feroli said, “we think this a minor stumbling block for a September” rate increase.
USB economist Tao Wang said Beijing would likely move cautiously, but investor expectations of further weakening “could quickly become entrenched” and cause the yuan to “depreciate quite quickly and significantly.”
She said that would represent a “sea change in China’s exchange rate policy” but would help to support flagging economic growth.