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China responded to President Donald Trump’s tariff threat with another escalation of the trade war on Monday, letting the yuan tumble to the weakest level in more than a decade and asking state-owned companies to suspend imports of U.S. agricultural products.

The moves antagonized Trump, who used Twitter to accuse China of “currency manipulation” which “will greatly weaken China over time!” He has previously criticized Beijing for not keeping to promises to buy more U.S. crops.

Stocks and emerging-market currencies sank on concern a prolonged conflict between the superpowers will weigh on global economic growth, while haven assets including the Japanese yen, U.S. Treasuries and gold climbed. Investors increased bets on Federal Reserve interest-rate cuts.

“It’s among the worst-case scenarios,” said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. “First markets sell off, then Trump wakes up and this all gets far, far worse.”

In a statement published Monday evening in Beijing, People’s Bank of China Governor Yi Gang said China won’t use the yuan as a tool to deal with trade disputes.

“I am fully confident that the yuan will remain a strong currency in spite of recent fluctuations amid external uncertainties,” Yi said, adding that the bank will work to ensure “reasonable and legal demand” by companies and the public for foreign exchange.

Trump last week proposed adding 10% tariffs on another $300 billion in Chinese imports from Sept. 1, abruptly ramping up the trade war between the world’s largest economies shortly after the two sides had restarted talks. Chinese bureaucrats were stunned by Trump’s announcement, according to officials who’ve been involved in the negotiations.

The threat of more tariffs came just as Chinese President Xi Jinping and other senior members of the Communist Party gathered for a secretive summer getaway in Beidaihe, a seaside town about a three-hour drive from Beijing. Xi had already faced pressure for weeks to take a harder stance on trade -- particularly after the U.S. blacklisted telecom equipment giant Huawei Technologies Co.

Editorials in state-run newspapers suggested Xi will reject any deal that either retains punitive tariffs or forces China to make concessions on issues like state-run enterprises that could weaken the party’s grip on power.

The harder line underlines a growing feeling in Beijing that Trump can’t be trusted to cut a deal, and that China would be better off waiting to see if a Democratic presidential candidate -- many of whom have criticized the use of tariffs -- takes office. The halt in agricultural purchases could hurt Trump in politically sensitive states ahead of the 2020 election.

The MSCI Asia Pacific Index slid 2.1% on Monday, the biggest drop since October 2018. European shares and S&P 500 index futures also retreated, while the yield on 10-year U.S. Treasuries declined about 8 basis points to 1.77%, the lowest level since 2016.

The onshore yuan weakened 1.4% to 7.0391 a dollar, falling sharply on Monday morning after the PBOC set its daily reference rate at a weaker level than 6.9 for the first time since December.

“Breaking seven is due to a mix of factors: an escalation of trade war, the softening of China’s economy and a willingness for the PBOC to tolerate higher volatility for the yuan,” said Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong. “The PBOC has entered uncharted waters, so it has to manage expectations carefully.”

In an earlier statement, the central bank attributed the yuan move to protectionism and expectations of additional tariffs on Chinese goods.

By linking today’s devaluation with the renewed tariff threat, the PBOC “has effectively weaponized the exchange rate,” said Julian Evans-Pritchard at Capital Economics in Singapore. “The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal.”

What Bloomberg’s Economists Say... “China appears to be posturing for worse to come in the trade war. Letting the yuan weaken past 7 against the dollar suggests it’s looking to buffer the economy from a more severe trade shock.”

-- David Qu, Qian Wan and Ye Xie

Allowing the yuan to weaken is not without risk for China. A mid-2015 devaluation spurred capital outflows and destabilized global markets, though tighter capital controls this time around should help prevent another exodus.

A cheaper currency also risks triggering yet more reprisals from the U.S. president, who has frequently warned that tariffs could go much higher. At a rally in Cincinnati last week he boasted of “taxing the hell out of China” until there’s a deal.

Tariff Man Returns President Donald Trump announced tariffs on additional $300 billion in Chinese imports Source: Bloomberg

The biggest damage from the trade war is the hit to business activity and confidence that comes from increased uncertainty, rather than the tariffs themselves, according to Wang Tao, China economist at UBS Group AG. For that reason, the weaker yuan may do little to offset the blow, she said.

China’s crop imports from the U.S. are another weapon at Beijing’s disposal. The country’s state-run agricultural firms have now stopped buying American farm goods, and are waiting to see how trade talks progress, people familiar with the situation said, declining to be identified as they’re not authorized to speak to the media.

Privately owned Chinese firms that had received retaliatory-tariff waivers on American soybeans from Beijing have also stopped buying the commodity due to uncertainty over trade relations, other people said. Corn and soybean futures fell on the news.

Trump has repeatedly complained that China hasn’t made the “large quantities” of agricultural purchases that he claims Xi promised when they met in Osaka at the G-20 summit.

Those accusations are “untrue” as Chinese companies have bought U.S. farm products, including soybeans, Cong Liang, Secretary General of the National Development and Reform Commission, said in an interview with China’s state broadcaster on Monday, citing purchases agreed to during a trade truce in 2018. Some deals haven’t been completed because the prices are not competitive, he said.

China’s commerce ministry didn’t respond to a fax seeking comment.

“China is giving up on its softer diplomatic strategy and is no longer willing to be Trump’s punching bag,” said Chua Hak Bin, an economist at Maybank Kim Eng Research Pte. “Trump’s tariffs threats are backfiring and triggering a full-scale trade war.”

— With assistance by Steven Yang, Isis Almeida, Shuping Niu, Yinan Zhao, Miao Han, Daniel Ten Kate, and Dandan Li

( Updates with Trump statement in second paragraph. )