Yuan closes down in face of dollar rally

(Updates to close) SHANGHAI, March 4 (Reuters) - The yuan closed weaker against the dollar on Monday after the dollar index and the yen both rallied in global markets on risk-off sentiment.

The central bank set a lower midpoint for the second straight trading session, down 0.4 percent to 6.2822, appearing to respond to a rally in the dollar index, which shrugged off the launch of wide-ranging spending cuts in the U.S. that kicked in on Friday. Volumes originally started low, booking slightly over $3 billion by midday, which traders said is typical of the market during the annual meetings of the Chinese People's Political Consultative Conference (CPPCC) and the National People's Congress (NPC). The CPPCC began on Sunday. However, the market revived somewhat in the afternoon to close slightly over $10 billion in transactions. The spot rate remained tightly range-bound all day, moving between 6.2298 and 6.2244. Markets are increasingly watching Chinese regulators' comments about China's reaction to a feared "currency war" that has seen many developed countries take steps to stimulate domestic growth that have caused their currencies to devalue - in the case of Japan, dramatically so. "In the near term, we are watching the Japanese yen more closely, and I think the yuan could depreciate," said a trader at a joint-stock bank in Shanghai. On the other hand, Chinese banks together bought a record amount of foreign exchange in January. Some economists attributed the purchases to strong market demand for CNY, which would imply market-driven bullish sentiment endures. Others believe the central bank is selling yuan into the market to hold the rate down as other currencies depreciate. Traders say the central bank appears to be setting its daily midpoint with an eye on the yen as well as the dollar index. "China is fully prepared. In terms of both monetary policies and other mechanism arrangement, China will take into full account the quantitative easing policies implemented by central banks of foreign countries," said central bank deputy governor Yi Gang, as quoted in the official Xinhua news service on Saturday.

The onshore spot yuan market at a glance:

Item Current Previous Change

(pct)

PBOC midpoint 6.2822 6.2798 -0.04 Spot yuan 6.2251 6.2237 -0.02

Divergence from midpoint* -0.91

Spot change ytd +0.08 Spot change since 2005 revaluation +32.95

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 1 percent from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET In the Hong Kong market, the premium between the offshore

yuan and the onshore yuan remained at a slight premium. The one-year non-deliverable forward contract ,

considered an imperfect indicator of expectations, continues to trade at prices implying depreciation over the next twelve months.

The offshore yuan market at a glance:

Instrument Current Difference from

onshore (pct)

Offshore spot yuan 6.2240 +0.02*Offshore non-deliverable 6.3210 -0.77**

forwards

*Premium for offshore spot over onshore

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. .

Click here for a factbox on recent offshore yuan bond issuances:

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> MARKET DRIVERS

- China eyes market forces to drive FX reform

- Offshore yuan set to further eclipse NDF market

- Taiwan yuan bonds may be dogged by policy barriers

- China restrains yuan rise in response to Asian currency weakness - Spot yuan has rallied strongly since late July 2012, and the PBOC is using its daily midpoint to restrain further appreciation. GRAPHIC: http://link.reuters.com/pyx74t - China's trade surplus surged in late 2012, but the surge was mainly due to weak imports rather than strong exports. GRAPHIC: http://link.reuters.com/qav68s - Corporate yuan purchases in recent monthls reflect strong yuan appreciation expectations. GRAPHIC: http://link.reuters.com/syx74t

- Hot money outflows may be putting downward pressure on the yuan. GRAPHIC: http://link.reuters.com/raz74t - Despite relatively stable dollar/yuan exchange rate, the yuan is appreciating on a trade-weighted basis. GRAPHIC: http://link.reuters.com/sed74t

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

(Editing by Sanjeev Miglani)