(Yicai Global) Jan. 10 -- China's central bank has notified some lenders to suspend the use of the counter-cyclical factor when calculating quotes for the yuan's daily reference rate, known as fixing, a Bloomberg report yesterday quoted sources as saying. The currency plunged both onshore and offshore.

No adjustments have been made to other parameters of the model, and the People's Bank of China did not give a reason for the latest change, the report said. The central bank also did not disclose the formula for calculating the counter-cyclical factor, which it introduced last year to reduce volatility.

The onshore yuan closed at 6.5207 against the dollar as of 4.30 p.m. yesterday, down 251 basis points from the official closing price on the previous day and down 223 basis points from the night-session closing price. The offshore yuan slipped below the 6.53 threshold and closed at 6.5330, down 360 basis points in one day.

The China Foreign Exchange Trade System considered adding the counter-cyclical factor to the submission of quotes for the yuan-dollar mid-rate, it said last May. Under that model, the yuan's central parity rate against the dollar was jointly determined by the day-session closing price on the previous day, changes in the yuan's exchange rates against a basket of currencies and the counter-cyclical factor.

"China's foreign exchange market is prone to irrational expectations due to a certain level of 'pro-cyclicality,' which distorts market demand and supply, and increases the risk of the market exchange rate overshooting," state-run news agency Xinhua reported today, citing the China Foreign Exchange Trade System.

The counter-cyclical factor helps correct irrational market expectations for the yuan's movement. It weakens the role of the previous day's closing price and changes in the yuan's exchange rate against a basket of currencies in determining the daily fixing rate. China hopes that the yuan's movements can more accurately reflect economic fundamentals and that pro-cyclical behavior can be reduced.

A currency's exchange rate should be determined by fundamentals. Before the revised model was brought in, the exchange rate failed to accurately reflect China's economic fundamentals. The yuan should have rallied against the greenback, given a falling dollar and the fact that China's leading economic indicators were improving overall. None of these factors justified depreciation at the time, which was mainly due to irrational expectations for a weaker yuan.