The second largest economy in the world has devalued its currency by around 2% against the US dollar in an attempt to prevent a further drop in exports.
This represents the biggest one-off devaluation to the Chinese yuan in 20 years.
As a result, stock markets and currency prices have fallen, with investors fearful that economic growth in China will be lower for longer.
The FTSE 100 has fallen by 1.06% and the Dow Jones fell by 1.21%. Brent crude fell to nearly $48.5 a barrel, its lowest value so far this year.
A devalued Chinese yuan will make exports more competitive and lower borrowing costs.
Commenting on the move by China, Schroders’ Emerging Markets Economist, Craig Botham said:
“We believe today’s moves by the People’s Bank of China (PBoC) do not signal the start of a substantial devaluation in the yuan as financial and social stability remain the overriding concerns for policymakers.
“The decision by the PBoC to alter the way in which it fixes the yuan – now taking into account the previous day’s closing spot rate – is a significant one. But contrary to many media headlines, we do not believe this is primarily a policy aimed at providing stimulus to exporters.
“The resulting depreciation, less than 2%, means that in trade-weighted terms the yuan is back to the level it was at ten days ago. This is not the kind of change that will see a boom in Chinese exports. Far more important is the increased role of the market in determining the value of the currency.”
Investors will be asking whether further devaluation of the Chinese yuan is likely.
There is also the risk of similar devaluation moves by other central banks.
Australia, Korea and India have already cut interest rates in order to maintain the competitiveness of their currencies, aiming to boost demand for their exports.
As one investment banker commented, this could well represent the “possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war.”