Yuan weakens as fresh tariff war dogs post-holiday trade

Adds analyst comment in paragraphs 8-9 and 17, equity market in paragraph 12

SHANGHAI, Feb 5 (Reuters) - China's yuan weakened against the dollar on Wednesday in the first trading session after the week-long holiday, pressured by a new trade dispute between the world's two largest economies.

Beijing on Tuesday slapped tariffs on U.S. imports in an immediate response to new U.S. duties on Chinese goods, renewing a Sino-American trade war as President Donald Trump sought to punish China for not halting the flow of illicit drugs.

But the losses in the yuan were capped by a persistent strengthening bias in central bank guidance, currency traders said, which they interpreted as an official attempt to limit yuan weakness.

Prior to the market opening, the People's Bank of China (PBOC) set the midpoint CNY=PBOC, around which the yuan is allowed to trade in a 2% band, at 7.1693 per dollar, its strongest since Nov. 8, 2024 and 968 pips firmer than a Reuters' estimate CNY=RTRS of 7.2661.

The central bank has been setting its official guidance on the firmer side of market projections since mid-November, which analysts and traders say is a sign of unease over the yuan's decline.

China's yuan hit a low of about 7.35 per dollar in 2023, weighed down by a combination of a widening yield differential with the United States and a slowing domestic economy. Many market watchers believe any sharp depreciation beyond the key level could mean China is loosening its grip on the currency.

Traders also said they would monitor the daily midpoint fixing, which is widely seen by markets as an expression of official policy stance.

"Any sharp depreciation beyond 7.35 or signs that the PBOC is loosening its grip on the yuan fixing rate could trigger massive selling pressure on the yuan and unleash market expectations for further depreciation," said Serena Zhou, senior China economist at Mizuho Securities.

"We believe the last thing Chinese policymakers want to see is soaring volatility in the FX and financial markets as they are working hard to revive economic sentiment onshore."

As of 0315 GMT, the yuan CNY=CFXS was 0.64% lower at 7.2845 to the dollar, compared with the previous close of 7.2469 last week.

While the onshore yuan was closed for the Lunar New Year holiday, its offshore counterpart CNH=D3 shed 0.6% against the dollar and hit a lifetime low this week. It last traded at 7.2917 around midday.

In equity markets, the benchmark Shanghai Composite index .SSEC dropped 0.36% and the blue-chip CSI 300 Index slipped 0.27% in morning deals. .SS

Still, investors will see any attempts by China to weaken the currency as a hint Beijing expects a protracted trade war and is using the yuan to counter the effect of tariffs, as it did during Trump's first term in 2018.

"While the tariffs imposed on China are not as aggressive as those on Mexico and Canada, this marks the beginning of another leg of the long-running trade war, with risks of further escalation," analysts at Barclays said in a note.

"We see intensified downside risk to the Chinese yuan (CNY) and other Asian currencies such as Korean won (KRW), Malaysian ringgit (MYR), and Thai baht (THB)."

During Trump's first term as president, the yuan weakened more than 12% against the dollar during a series of tit-for-tat U.S.-China tariff announcements between March 2018 and May 2020.

"The future path of U.S.-China trade conflicts remains highly uncertain, and reactions from the U.S. to China's retaliation, the potential Trump-Xi phone call, and PBOC's daily dollar-yuan pair (USD/CNY) fixing in the coming days are key events to watch," analysts at Goldman Sachs said in a note.