China's leadership is prepared to let the country's currency weaken to support its exporters as global trade tensions deepen, experts told CNBC.
But, they said, Beijing will prevent any disorderly depreciation in the dollar/yuan exchange rate beyond 7, a politically sensitive level upon which Washington may seize to label China a currency manipulator.
On Thursday afternoon, the yuan was at about the 6.84 level to the dollar.
Beijing's currency policy stands at a crossroads this month. The outlook for the yuan ultimately hinges on whether the U.S. administration makes good on its threats to slap tariffs on an additional $200 billion worth of Chinese imports.
"In a scenario where there is an immediate lift in tariffs, say closer to 20 percent rather than 10 percent along with threats of more to come, then we suspect the 7 CNY barrier is more likely than not to be breached," said Rodrigo Catril, senior currency strategist at National Australia Bank, referring to a common shorthand for the yuan. "For now we are leaning towards the softer scenario which allows for CNY to trade sub 7."
The currency fell for 11 straight weeks to Aug. 24, a record losing streak reflecting looser monetary policy, patchy progress on U.S.-China trade talks and a broadly outperforming U.S. dollar.
Concerned about outflows to developed markets, Beijing reintroduced measures to stabilize its managed currency, including a calculation method called the counter-cyclical factor (CCF) that's aimed at keeping the yuan's daily midpoint fixed to a relatively stable value. Put simply, the strategy appears aimed at defending the currency from attack by market speculators.
"Underlying pressure points on the yuan — weaker growth and US-China trade tensions — appear likely to worsen," said Teck Leng Tan, director and foreign exchange analyst at UBS CIO Wealth Management. "Chinese policymakers, too, have shown more tolerance of yuan declines, in line with the broader [foreign exchange] market. Curbing speculation, rather than outright depreciation, appears to be the real objective of the CCF tool."
UBS' Tan added: "We cannot rule out a significant rise past seven yuan to the dollar if trade tensions escalate or if Chinese economic data worsens in the months ahead."
The Chinese yuan will likely end the year at 6.95 to the U.S. dollar, according to the median of 31 forecasts in a CNBC survey compiled in August and updated to take account of the reintroduction of the stability measures in late August by the People's Bank of China, the country's central bank.