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Flash crash of pound piles pressure on already weak yuan

The flash crash of the British pound proved a test for Beijing in the first week of the yuan’s inclusion in the International Monetary Fund’s currency basket.

Amid the fallout from Britain’s vote to leave the European Union, the pound shed nearly 10 per cent against the greenback on Friday to briefly hit a 31-year low, adding more volatility to the mix as authorities in Beijing try to ward off depreciation bets against an already weak yuan.

But economists said the status of London as a financial hub was unlikely to be shaken and Beijing might keep using Britain’s offshore yuan market to expand yuan products to meet ongoing demand.

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The offshore yuan weakened against the greenback in the first week after its inclusion in the IMF’s Special Drawing Rights on October 1, as the onshore market closed for the week-long National Day break.

The offshore yuan closed at 6.7080 against the greenback on Friday after hitting a nine-month low of 6.7182 briefly after the flash crash. That compared with a closing price of 6.6788 a week earlier.

The turmoil highlights the fragile sentiment in the market just as the authorities are seeking stability.

Zhou Xiaochuan, governor of the People’s Bank of China, said in Washington on Thursday that China was “striving to find a balance between raising the yuan’s flexibility and keeping a stable exchange rate. He underscored China’s commitment to market-oriented exchange rate reform and insisted that pressure from capital outflows had faded.

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Cheung Kong Graduate School of Business professor Li Wei said the flash crash underscored the market’s fragile sentiment, saying it still “nursed a grudge against the Brexit result”.

“Sterling is not a safe haven currency, but the cheaper pound means it is a good time to travel there,” he said.

But, Li said, London would remain a favoured place for Beijing to increase the range of yuan assets, such as issuing offshore yuan bonds to foreign investors interested in holding the currency.

The weakness of the pound and yuan comes as the US dollar strengthens on expectations the US Federal Reserve will raise interest rates in December.

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“Unless the US dollar weakens, the pressure on the weak yuan will remain,” Industrial Bank chief economist Lu Zhengwei said. “But the further market orientation will help the offshore yuan market to develop.”

The onshore yuan closed at 6.6745 against the greenback on September 30.

The widening spread between offshore and onshore currency will add pressure on the onshore rate when the market reopens ­today.

The weakness in the offshore yuan also comes as China’s official foreign reserves fell for the third month in September to US$3.17 trillion.

China International Capital Corporation said that given the expectations of a Fed rate hike and the weakening pound, the strengthening US dollar might further depress the yuan.

“An unstable yuan exchange rate will add uncertainty to policies, which will not benefit investment and consumption … The authorities should … avoid major volatility in the yuan’s exchange rate in the fourth quarter,” it said.