China's tight rein on yuan's gains prolongs market deadlock
* PBOC seen allowing mild yuan appreciation before year-end
* Companies shun dollars due to oversupply
* PBOC may shift strategy in early 2013 to break deadlock
* That may cause firms to reconsider their stand as well
SHANGHAI, Dec 5 (Reuters) - The yuan firmed marginally on Wednesday morning, as the People's Bank of China allowed an incremental rise in the daily trading range, but the market remained deadlocked due to the central bank's refusal to let the yuan advance more.
Spot yuan stood at its upper limit of 6.2242 per dollar by midday, having spent virtually the whole morning there, and showed a gain of 14 pips from Tuesday's close of 6.2256.
The scale of the yuan's advance was scripted by the PBOC setting the yuan's daily midpoint at 6.2871 versus the dollar, 14 pips stronger that Tuesday's midpoint.
The central bank allows the exchange rate to move a maximum 1 percent either side of the mid-point each day.
Traders expect the low trading volumes in the onshore currency market to prevail until early 2013, with the central bank leaving it to the market to whittle down an overhang of dollars.
The overhang stems from positions built up in the first half of the year, when the yuan was weakening.
Trading remained sluggish, with volume of $1.5 billion on Wednesday morning. That was up from $463 million on Tuesday morning, but still below its long-term average.
The market's average full-day volume was $13.9 billion in the first nine months of this year.
"As the PBOC has permitted the yuan to rise slightly over the past two sessions, companies are slightly more willing to do business this morning," said a trader at a Chinese state-owned bank in Shanghai.
"But the current deadlock is unlikely to be broken until early 2013, as both the central bank and market are unlikely to make concessions for now."
The market, according to traders, is hoping that the central bank gives way by either adjusting the daily trading range to let the yuan strengthen further, or by buying large amounts of dollars.
But so far the PBOC has only appeared to buy when the market's illiquidity became pronounced.
The PBOC is expected to let the yuan strengthen slightly this month, traders said.
In recent years, the central bank guided the currency higher in last few weeks of a year -- possibly in order to meet pre-determined annual appreciation targets and deflect U.S. criticism that the Chinese currency is undervalued.
Traders expect the PBOC to let the yuan strengthen slightly to around 6.2 by the end of this year, but even so, few companies are expected to attempt to build large yuan positions in coming weeks due to the lack of yuan liquidity in the market.
But many traders expect the central bank to shift its strategy next year to help resolve the deadlock, mostly likely by injecting yuan liquidity into the market.
In China's rigid foreign exchange regime, the PBOC has always been the ultimate supplier of liquidity. But traders say the PBOC now appears determined to reduce its interventions in the market, even if it must endure a period of weak liquidity.
The yuan now stands 1.1 percent up against the dollar for the year so far, rallying 2.8 percent from its late July low.
(Editing by Simon Cameron-Moore)