(Bloomberg) -- China’s yuan pared losses seen Friday after the central bank signaled its support for the managed currency via a stronger-than-expected daily reference rate.

The People’s Bank of China set the yuan’s fixing at 7.0996 per dollar on Monday versus 7.2222 as forecast by analysts in a Bloomberg survey — the largest strengthening bias since November. The fixing was set at 7.1004 in the previous session.

The onshore yuan rose as much as 0.5% to 7.1902 per dollar, the most since December. State-owned banks dumped dollars onshore and there were signs of tightness in offshore yuan liquidity, which also supported the currency, according to traders who asked not to be named as they were not authorized to speak publicly.

“Today’s fixing is a clear signal from the authorities that they do not intend to allow further weakening in the yuan,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group. “Last Friday’s moves were an over-reaction by the market and today’s fixing is firmly aimed at correcting that perception.”

China’s currency has been a source of stability in the global FX market and an anchor for its regional peers, according to strategists. A signal from officials that they are open to letting the yuan weaken risks increasing volatility which may spill over into regional and global currency markets.

The onshore yuan dropped the most in more than two months Friday as traders bet that day’s fixing suggested officials were open to depreciation. It weakened through the closely-watched 7.20 level against the dollar, which had acted as a key support since November. The currency traded around 7.2020 at lunchtime in Beijing on Monday.

“We expect the PBOC to guard against further yuan weakness for now and smooth any sharp jumps in CNY/CNH after witnessing the market reaction last Friday,” said Alex Loo, a macro strategist at TD Securities. 

Read: China Jolts FX Markets as Yuan Suffers Worst Day in Two Months

Support for the yuan is vital for its stability this year with the Chinese economy still facing a slew of woes including a property downturn and weak market sentiment. The central bank faces a delicate balancing act, trying to maintain supportive monetary policy while keeping capital outflow pressure contained amid a resilient dollar.

The yuan may still depreciate toward levels seen last year, but the pace will be gradual, according to RBC Capital Markets. 

The currency could still revisit the 7.30 per dollar level going forward, “but it cannot be allowed to happen over just a few days amid high volatility,” said Alvin T. Tan, head of Asia FX strategy. “FX stability remains a cornerstone of PBOC policy.”

The PBOC signal came after a robust warning from Japan’s currency chief against speculative trading in the neighboring yen, after recent weakness there. Vice finance minister for international affairs Masato Kanda told reporters Monday that Japan will take appropriate action, with nothing ruled out.

Japan’s Currency Chief Delivers Most Robust FX Warning in Months

Chinese authorities may have concerns about the competitive aspect of a weaker yen, which could heighten if the yen continues to slide, said Charu Chanana, Saxo Markets head of FX strategy. At around 151 per dollar, the Japanese currency is not far off a more than three-decade low.

If the yen weakens past 152 per dollar, “we could likely see the PB0C letting the onshore yuan weaken further towards 7.25,” she said.

--With assistance from Ran Li, Iris Ouyang and Tania Chen.

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