China unlikely to aggressively devalue yuan to offset impact of U.S. tariffs, economists say

China will not be able to wield a weaker yuan as a weapon in its deepening trade war with the U.S. due to concerns that such a move could trigger financial market instability, market watchers told CNBC.

The Chinese offshore yuan weakened to a record low of 7.4287 against the U.S. dollar earlier this week after the People's Bank of China set its midpoint rate at its weakest level since 2023. Similarly, the onshore yuan on Thursday weakened to 7.3509 against the greenback, its lowest since 2007, data from LSEG showed.

The move sparked speculation that Beijing would allow the currency to weaken further to cushion the impact of U.S. President Donald Trump's tariffs. However, analysts caution that a significant weakening of the yuan could have ripple effects, including triggering capital outflows, something policymakers are keen to avoid. Indeed, the yuan has since strengthened both onshore and offshore.

Among 11 analysts polled by CNBC, a majority do not see the currency weakening significantly in the long-term. Instead, economists expect the central bank to engineer an orderly and gradual depreciation.

"RMB (Renminbi) devaluation will not be part of China's retaliation toolkit to U.S. tariffs," said HSBC's head of Asia FX Joey Chew, referencing another name for the Chinese yuan.

"In fact, rapid depreciation could weaken consumer confidence and risk capital flight," she told CNBC.

Capital outflows accelerated in 2015 when China devalued its yuan. China saw nearly $700 billion worth of capital flight that year, data from the Institute of International Finance showed.

With China's economy already stuttering and a rapid rise in U.S. tariffs threatening to hobble exports, a rapid outflow of capital from the country may complicate policymakers' jobs even further.

"Devaluation is no longer an effective trade weapon," said Dan Wang, China Director at Eurasia Group, who added that doing so will be "inviting financial crisis on its own."

Capital flight is Beijing's top concern, she said.

"The government will try everything it can to assure the market that it has the ability to defend the yuan against the U.S. sanction and that no one in the market should short yuan," Wang added.

There are also limits to the benefits a weaker yuan could unlock now that the U.S. tariff rate on Chinese imports currently stands at 145%.

"How can a country depreciate the same amount of exchange rate by the same level without triggering financial instability. It will be very difficult," said Jianwei Xu, senior economist at Natixis.

While major currencies like the U.S. dollar and Japanese yen have a free-floating exchange rate, China tightly regulates the value of the yuan within its domestic market. 

Each morning, the PBoC establishes a daily midpoint fix, based on the yuan's previous day's closing value and input from interbank dealers. The onshore yuan is only allowed to trade within a narrow band of 2% above or below this reference rate.

"I think China wants to be seen as the center of stability on every variable, including the exchange rate," said veteran investor David Roche.

A weaker yuan could also arguably make it "easier" for the U.S. given how China is its largest supplier of goods, Roche pointed out.

"The best way to make the Americans pay for this is to keep the currency stable," he said.

Chinese policymakers' commitment to stability was underscored by a series of measures to prop up the yuan earlier this year when a sharp surge in the U.S. dollar sent other currencies tumbling around the world. That effort aimed to dissuade market participants from placing one-way bets on the yuan's slide.

The central bank is guiding some gradual yuan depreciation via the fixing but a sharp devaluation is not likely, according to Ken Cheung, Mizuho's chief Asian FX strategist, whose year-end forecast of the onshore USD/CNY rate was the lowest among the analysts polled at 7.12.

Rather than using currency depreciation to counter the impact of the U.S. tariffs, Cheung said the PBoC might instead "introduce more two-way FX volatility to adjust with the choppy FX market conditions."

Christopher Wong, OCBC's FX strategist, said that in the very near term, the bank does not rule out "wild swings" in the currency that would see it trade between 7.20 and 7.50 for both onshore and offshore currencies.

Not everyone CNBC surveyed believes that Beijing will opt for a stable yuan. If the elevated tariffs imposed by the U.S. and China stay in place, Capital Economics sees the yuan depreciating significantly.

Jonas Goltermann, deputy chief markets economist at Capital Economics, told CNBC that he expects the USD/CNY rate to hit 8 by the end of the year. However, given how the U.S.-China trade war has evolved in recent days, Goltermann said the markets could "get there sooner."

However, he added that even that would not fully offset the hike in U.S. tariffs. 

China may be more likely to utilize domestic stimulus to offset lost trade and project market stability, said Kamil Dimmich, portfolio manager at North of South Capital LLP. That includes a stable yuan, perhaps even strengthened by repatriating capital from the US treasury market, he elaborated.

On Friday, the PBoC also reaffirmed its plans for a "moderately loose" as Beijing gears up for heightened uncertainty amid the rapidly intensifying global trade war.

—CNBC's Evelyn Cheng contributed to this report.