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Why There's a Lot More 'Juice' in the Yuan Trade

Dusko Jovic | E+ | Getty Images

Even as China gets serious in fending off speculative inflows that could cause the yuan to jump and destabilize the economy, analysts tell CNBC the measures taken by Beijing will do little to derail a strengthening Chinese currency.

Strength in the yuan has taken markets by surprise in recent times, appreciating at a rapid pace of around 1.5 percent against the U.S. dollar since mid-February. On Thursday it hit a record high of 6.1336 per dollar in morning Asian trade after the People's Bank of China (PBOC) fixed the yuan mid-point at the highest level since the 2005 revaluation.

(Read More: Yuan Surge Shows China Isn't Worried About Economy)

The central bank indicated on Wednesday that it was ready to take steps to control the wave of capital inflows that threaten to destabilize exports as the yuan appreciates rapidly days after the foreign exchange regulator came up with new rules to crack down on inflows disguised as trade payments.

On Thursday, Reuters reported that the central bank was on course to inject 84 billion yuan ($13.6 billion)) into the market for this week.

But analysts told CNBC that the yuan upward momentum is intact and the authorities may not do anything drastic to stem that.

"There is still a lot of juice in this trade," said Stuart Oakley, managing director of Asian currency trading at investment bank Nomura. "To be short dollars and long yuan is the real trade and it seems to have by-passed the market completely," he added.

The recent steep appreciation in the yuan is a "monumental move by Chinese standards" according to Oakley.

(Read More: China's Big Dilemma — Currency Reform)

While the yuan is still a managed currency the Chinese have hinted in recent months that they could allow market forces to play a greater role in its movement. At present the dollar/yuan exchange rate may rise or fall one percent from the mid-point set each day.

Nomura's Oakley is confident that the rapid appreciation in the yen is a sign that China is close to taking steps to open up its currency in the near future. He forecasts full liberalization to take place over the next five years.

"It is clear to us this move [higher] is a precursor to them widening their trading band and moving along the path to currency liberalization. Everyone is so obsessed with what is happening in Japan and the hunt for yield that the real trade has been missed," he added. The yuan trading band was last widened a year ago.

(Read More: Will the Fall in New Factory Orders Trigger China Action?)

Chinese leaders are due to meet with U.S. Treasury Secretary Jack Lew and Secretary of State John Kerry in Washington in July, by which time Oakley expects the Chinese leadership to want to come armed with some positive news on how China is taking steps towards full liberalization of its currency.

China's tight controls on its national currency have long been an issue of contention between the world's two largest economies. The U.S. has in the past accused China of deliberately keeping its currency weak to make its exports more attractive, and putting U.S. exporters at a disadvantage.

"We think the strong point of the yuan is going to occur during the week of strategic economic dialogue...in the second week of July. They will want to show up in Washington and say we are moving towards currency liberalization and guess what we have just widened our currency band. I think the widening band will be doubled," added Oakley.

According to Stephen Schwartz, Asia chief economist at Spanish bank BBVA, Chinese authorities have displayed the willingness to allow market forces to determine the yuan's value.

"They have tightened some regulation to prevent shorting of the currency and are clamping down on these illegal hot money inflows. But it is interesting that they are not intervening to manage the exchange rate to keep it from appreciating faster...I think one could read a positive view of this that they are allowing market forces to determine the exchange rate," he added.

(Read More: Yoshikami: What's Wrong with China Equities?)

— By CNBC.Com's Katie Holliday; follow her on Twitter @HollidayKatie

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