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The People's Bank of China allowed the yuan to depreciate almost 2 percent against the U.S. dollar to levels last seen three years ago, sending a shock through currency markets.
In a statement, the Chinese central bank said that it had changed the way it calculated the currency's daily midpoint against the greenback, now taking the midpoint from market-makers quotes and the previous day's closing price.
The PBOC set Tuesday's midpoint at 6.2298 per U.S. dollar, down from 6.1162 on Monday.
China's spot yuan fell nearly 2 percent in early trading on Tuesday, heading for its biggest daily drop ever. The yuan was quoted at 6.3080 versus the dollar in early trade, weakening from 6.2097 at the close on Monday. It fell 0.7 percent during the global financial crisis in December 2008.
"It looks as though the weakened trade numbers were the last straw for China's tolerance of a strong exchange rate in the face of weak global demand for its exports," Sean Callow, senior currency strategist at Westpac told CNBC.
Chinese exports slumped 8.3 percent in July, the biggest drop in four months and far worse than expectations for a 1 percent fall. Exports to the European Union fell 12.3 percent in July while those to the United States dropped 1.3 percent.
"It is certainly to be welcomed after an extended period of stability in dollar-yuan," he said.
The move had a knock-on effect on currencies throughout the region, with the Singapore, New Zealand and Australian dollars, as well as the South Korean won, also dropping against the U.S. dollar in reaction.
"If the yuan is sliding then why not join in," Callow said, explaining the depreciation in other Asian currencies. "If China's a rival exporter, and all of a sudden it's allowing its currency to weaken, then you're more inclined to let your currency weaken."
Callow said the PBOC's decision had altered his medium-term outlook for the Chinese currency, saying that it was more likely to participate in any broad regional depreciation against the greenback should the Federal Reserve hike interest rates in September.
"Up until an hour ago, we wouldn't have included the yuan as being a currency to weaken significantly in the face of a rate hike, but this changes the outlook," he said.
When asked whether the central bank's move was a form of currency manipulation, analysts said no.
"They've been holding up the currency. All they are doing now is letting is fall closer to where it should be," said Mark Jolley, equity strategist at CCB International Securities. "It's not manipulation, it's just moving towards reality," he added.
Callow had a similar view: "It's a lot less manipulation in a way, previous fixings did not make a lot of sense. Daily fixings should be representative of the market."
- Reuters contributed to this report.