China's central bank has made a change to the regime used tomanage the yuan, effectively removing a component used by banks tocalculate their submissions to the currency's daily reference rate,according to people familiar with the matter.

The People's Bank of China recently told some lenders thatcontribute to the rate—known as the fixing—to adjust their use ofthe “countercyclical factor” in such a way that it would have noimpact on the mechanism, said the people, who asked not to beidentified as the details are private. They said the change hasalready taken effect.

The yuan, which headed for its biggest drop in two months on thenews, is allowed to move a maximum of 2% either side of the fixing.Analysts said the change shows China is confident in the yuan'scurrent trajectory, which has been one of steady appreciation.

China introduced the countercyclical factor last year in a bidto reduce volatility in the yuan, which had weakened for threestraight years, triggering the introduction of capitalcontrols.

Market watchers said it gave the PBOC more control over thecurrency, but undermined earlier efforts to make the yuan moreaccessible and market-driven. Greater control over the fixing—alongwith a steady economy and a retreat in the dollar—helped ignite arally in the yuan in the second half.

“This is not surprising as the expectation for depreciation haswaned,” said Raymond Yeung, chief greater China economist atAustralia & New Zealand Banking Group in Hong Kong. “Thissuggests that the authorities expect to see the exchange rate tofloat within a reasonable range in the near term.”

In an email to Bloomberg News, the PBOC said that it's up to thebanks that contribute to the fixing to handle their owncalculations. Lenders look to fundamentals when determiningadjustments to the components that make up the factor, the centralbank said.

The factor counteracts sentiment-driven volatility in the marketand the potential for “herd behavior,” China Foreign Exchange TradeSystem, which falls under the central bank, said on its websitearound the time it was introduced.

It's also typically been seen as a tool to address yuandepreciation without draining foreign-currency reserves. GoldmanSachs estimates that on most days since October, the fixing endedup stronger after the factor was incorporated.

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Dollar Weakness

The onshore yuan fell 0.4% to 6.5258 per dollar as of 6:28 p.m.in Shanghai, set for its biggest one-day decline since Nov. 3.Offshore, the currency dropped 0.5%, the most since September. Thechange to the fixing is likely to boost volatility in the currencyas it will allow for great flexibility, analysts at Nomura Holdingssaid.

The yuan's strength over the past year paved the way for thepolicy shift. With the dollar in a protracted decline, outflowsfrom China have slowed resulting in the yuan's turnaround. Thecurrency strengthened for the first time in four years in 2017, andreached a four-month high on Monday.

Until this shift, the yuan's fixing was calculated based on theprevious day's closing price as of 4:30 p.m., its moves against abasket of currencies, and the counter-cyclical factor. The lattercounteracted the impact of the previous day's trading and anysignificant currency moves globally, people familiar with thematter told Bloomberg last May, thereby curbing excessivevolatility.

The easing in depreciation pressure has allowed China to take astep toward making yuan trading more market-based.

“This is one direction to go—and an easy way out—if theauthorities want to proceed with FX reform,” said Frances Cheung,head of Asia macro strategy at Westpac Banking Corp. in Singapore.“The recent yuan fixing pattern also suggests that the factor hasnot been utilized. That said, they reserve the flexibility tore-deploy the CCF if needed.”

From: Bloomberg News

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