The central bank has allowed the yuan to move in a relatively wide range after PBOC governor Zhou Xiaochuan said last week that conditions were now ripe for the yuan's exchange rate to float more widely.Last week, its midpoint dropped 0.41 percent from Monday to Thursday, the biggest four-day fall since August 2010, then on Friday it posted the biggest single-day rally in four months.
Traders and analysts said the PBOC is apparently using the midpoint to widen the yuan's movements in either direction, a move that will gradually prepare both the domestic and global markets for sharper fluctuations of the Chinese currency.
But they said they do not expect the greater volatility will automatically lead to yuan depreciation, adding that they still expect the currency to firm over the year.
"The yuan appears to be ending its years of trend of one-year appreciation and is set to fluctuate in either way from now on," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen.
"This will force Chinese companies to gradually get used to increasing exchange rate risk," he said. "But the trend for the yuan to continue to appreciate slowly will continue this year."
The central bank set the yuan midpoint at 6.3282 to the dollar on Monday, making the Chinese currency fall 209 pips or 0.33 percent from the previous day's fixing.
It was the second biggest daily fall in the midpoint since China established its foreign exchange market in 1994. The biggest single-day fall occurred on August 12, 2010, when the yuan dropped 247 pips or 0.36 percent.
The yuan fell to 6.3239 against the dollar around midday, down from Friday's close of 6.3107.
"It's not a direct response to the trade numbers as such," said Robert Minikin, senior foreign exchange strategist at Standard Chartered in Hong Kong, referring to monthly trade data at the weekend which showed that China posted its largest monthly trade deficit in a decade.
"It's simply a reflection of the fact that the authorities want two-way variability, and they're prepared to adjust the fix to reflect that," he said.
CONDITIONS MATURE
China has long stated its intention to promote greater two-way flexibility in the tightly-controlled yuan, which has appreciated more than 30 percent since July 2005, when Beijing conducted a landmark revaluation of the currency.
Analysts say that the time is now ripe to widen the trading band from the current 0.5 percent.
The seasonal pattern of weaker exports in the first half of the year, combined with smaller cross-border capital flows compared to last year, means that a widening band move would likely not cause uncontrolled appreciation or excessive volatility in the near term.
The yuan generally moves less than 0.2 percent a day, so the immediate impact on the spot market of widening the trading band would be limited. Its main significance would be to further reinforce the signal sent by recent volatility in the midpoint.
Before it embarks on broadening the official trading band, they said. The PBOC should first encourage the yuan to move more widely both in intraday trading and with more volatile midpoints from day to day, traders say.
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