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China's Yuan Breaches 7.0 vs Dollar on Strong CPI

The yuan breached the closely watched 7.0 mark versus the dollar on Monday after the central bank fixed its reference rate at a post-revaluation high and the government reported higher-than-expected consumer price inflation for April.

The yuan also jumped in the offshore forwards market after a plunge over the past two weeks, which had been driven in part by speculation about a change in China's currency policy after the central bank slowed the yuan's pace of appreciation in April.

Eugene Hoshiko

"Monday's central bank reference rate indicates the yuan should have now effectively breached the psychologically important 7.0 level after lingering there for about a month," said a dealer at a major European bank in Shanghai.

"That means the government is still committed to a policy of using the yuan exchange rate to help fight inflation, although April's pause in yuan appreciation signals that the currency may not rise, in the near term, as fast as in the first quarter."

The yuan rose to 6.9830 against the dollar in early trade on Monday from Friday's close of 6.9918, after the central bank fixed the currency's daily mid-point, or reference rate, at 6.9820, up from Friday's 7.0005 and the highest since the currency was revalued in July 2005.
The previous post-revaluation high of 6.9837 was set on April 23.

Several dealers expected the yuan to rise to between 6.93 and 6.95 versus the dollar by the end of May, translating into a monthly gain of 0.5 to 0.9 percent.

They maintained their forecasts for the yuan to rise 8.5 to 10 percent for all of 2008, taking into consideration its jump in the first quarter.

China said on Monday its annual consumer price inflation quickened to 8.5 percent in April from 8.3 percent in March, lingering near a 12-year high of 8.7 percent hit in February.

The April figure, which was higher than economists' forecast of 8.3 percent, was in line with a Reuters report last Thursday based on information from sources familiar with the data.

Forwards Recover

Higher inflation plus the central bank's strong mid-point helped to push the one-year offshore dollar/yuan non-deliverable forwards to 6.5090 bid against the dollar on Monday morning, a sharp gain from Friday's close of 6.5510.

The NDFs' latest level implied yuan appreciation of 7.27 percent against the dollar in the next 12 months from Monday's spot mid-point, up from 6.86 percent on Friday.

The implied yuan rise fell to nearly 6.0 percent last week, less than half a post-revaluation high of 13.79 percent in mid-March, partly due to concerns about a possible change in policy.

JP Morgan said in a research report on Monday that the recent steep slide in implied yuan appreciation in the NDF market, in contrast to relative stability in spot rates, suggested it may now be worth taking long positions in the yuan on the forwards market.

"We continue to view the fundamental case for CNY (yuan) appreciation as remaining intact, as CNY strength remains the appropriate policy tool to moderate inflows, curb money supply growth and address imported inflation," it said.

In another sign of recovering sentiment towards yuan appreciation, long-term dollar/yuan volatilities jumped on Monday to their highest level since the Chinese currency's revaluation.

One-year offshore dollar/yuan volatilities surged as high as 6.90 percent bid from Friday's close of 5.3 percent.

Until Monday, the central bank had prevented spot yuan rates from rising much beyond 7.00 since the initial break above that level in early April.

Several government-connected analysts had also talked of the possibility of appreciation slowing, or the yuan even entering a depreciation trend, further dampening sentiment.

In April, the yuan posted its smallest monthly gain in a year, at only 0.35 percent, after appreciating 4.2 percent in the first quarter, for an annual rate of 17 percent.

The first-quarter surge followed the central bank's declaration late last year that it would use the exchange rate actively to fight inflation.

"The slowdown in the yuan's rise in April led to heavy losses for speculators betting on dramatic yuan appreciation," said a dealer at a major Chinese state-owned bank in Beijing.

"With speculators punished, the central bank is now likely to stick to slow and steady yuan appreciation policy in coming months."