(Adds quotes, details and background) SHANGHAI, May 26 (Reuters) - China's yuan on Friday extended the previous day's big gain, hitting its strongest level in more than three months, and the Chinese currency was on track for its best week since mid-January. At midday, spot yuan was trading at 6.8566, after earlier reaching 6.8493, its firmest since Feb. 16. On Thursday, the day after Moody's Investors Service downgraded China's sovereign rating, state banks sold dollars and the yuan strengthened 0.3 percent for the day. Traders said on Thursday that Chinese authorities appeared to be putting on a show to support the yuan in the wake of Moody's downgrade. But speculation is also swirling that China may be adjusting the way it calculates the yuan's daily midpoint rate to tamp down volatility. China plans to change the way it calculates the yuan's daily midpoint rate against the dollar, adding a "counter-cyclical adjustment factor" that may blunt the impact of market swings, Bloomberg reported on Friday. Prior to the market opening on Friday, the People's Bank of China set the midpoint rate at 6.8698 per dollar, weaker than the previous fix of 6.8695. Friday's slightly weakened official guidance was still much firmer than market expectations, a situation that has persisted for weeks. At 6.8566 at midday, the onshore spot was 139 pips firmer than the previous late session close and 0.19 percent stronger than the midpoint. The sudden surge in the yuan showed that the Chinese authorities might "attempt to give a warning to the RMB bears who speculate on RMB depreciation following the downgrade on China", Ken Cheung, Asian FX strategist at Mizuho Bank in Hong Kong. In downgrading China for the first time in nearly 30 years, Moody's said it expects the financial strength of the economy to erode in coming years as growth slows and debt continues to rise. Traders in the onshore market said there was some corporate demand for the greenback in morning trade on Friday, but a much stronger offshore counterpart curbed the onshore yuan from sinking. The offshore yuan rose to 6.8360 per dollar, its strongest intraday level since Feb.8, before retreating to 6.8426 as of midday. It was still traded 140 pips or 0.2 percent firmer than the onshore spot. The strength in the offshore yuan was supported by signs of short-term liquidity stress as seen in a rise in Hong Kong's overnight yuan borrowing rate, which jumped to 7.75650 percent on Friday, the highest level since January. CNH Hibor, The CNH Hong Kong Interbank Offered Rate benchmark, set by the city's Treasury Markets Association (TMA), showed rates up across maturities. The one-week contract surged to the highest level since Jan.23. The implied overnight deposit rate for the offshore yuan rose to 9.063 percent at one point in morning, the highest since January 6. The global dollar index rose to 97.301 from the previous close of 97.248. Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan's value, traded at 7.0375, or 2.38 percent weaker than the midpoint. One-year NDFs are settled against the midpoint, not the spot rate.
The yuan market at 0410 GMT:
Item Current Previous Change PBOC midpoint 6.8698 6.8695 0.00% Spot yuan 6.8566 6.8705 0.20% Divergence from -0.19%
Spot change YTD 1.31% Spot change since 2005 20.71%
Item Current Previous Change Thomson 93.83 93.39 0.5
Reuters/HKEX CNH index
Dollar index 97.301 97.248 0.1
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 2 percent from official midpoint rate it sets each morning.
OFFSHORE CNH MARKET
Instrument Current Difference
Offshore spot yuan 6.8426 0.20% * Offshore 7.0375 -2.38%
*Premium for offshore spot over onshore
**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. .
(Reporting by Winni Zhou and John Ruwitch; Editing by Kim Coghill)