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China stumps market, pushes yuan to 7-month highs

* Yuan's midpoint rate gets sharply strengthened

* Traders say big state-owned banks sold dollars to support yuan

* C.bank has 'let the yuan bulls loose' - analyst

* Offshore yuan has gained 2 pct in last six sessions (Adds detail of dollar sales, bylines)

SHANGHAI, June 1 (Reuters) - China's central bank on Thursday pushed the reference rate for the yuan up by 0.8 percent, the midpoint's second largest one-day appreciation since the currency was de-pegged from the dollar in 2005, as it wages war on depreciation expectations.

The spot rate followed suit, crossing the 6.8 per dollar level for the first time since Nov. 11 to trade at 6.7896 at 0450 GMT.

Traders said major state-owned banks were selling dollars, which helped keep the yuan strong. Many market participants believe dollar selling by the biggest state-owned banks in recent weeks has been a key part of government efforts to support the exchange rate.

The yuan has been guided about 1.5 percent higher against the dollar since May 24, when Moody's Investors Service downgraded China's sovereign credit rating for the first time since 1989.

In the offshore market, the currency has strengthened by about 2 percent over that period.

"The PBOC has let the yuan bulls loose in the China shop," said Stephen Innes, senior trader at OANDA in Australia, referring to the People's Bank of China.

"Needless to say, the market is a tad shell-shocked this morning while searching for some policy clarity from the PBOC."

Chinese stocks and the yuan have risen since the Moody's downgrade, and some analysts believe the hand of the state is behind moves designed to dissuade bears.

FIXING CHANGE

The government last week also announced a proposed new methodology for setting the yuan's midpoint, around which the currency is allowed to trade as much as 2 percent up or down.

The new mechanism would take into consideration "counter-cyclical factors", although no details were given. Traders and economists believe this potentially gives the central bank more leeway to fix the rate as it sees fit, irrespective of prevailing market conditions.

Last year, the yuan slipped some 6.5 percent against the dollar, and with uncertainty hanging over the Chinese economy and efforts to de-leverage the financial sector, many economists had forecast the slide would continue.

But so far this year, it has gained about 2.3 percent, and the appreciation of recent days has forced some analysts and investors to reconsider their outlook.

"The sudden surge in the yuan caused some panic among bank clients. Unlike the previous rallies in the yuan, this time, the one-way expectation of yuan depreciation has changed," a Shanghai-based trader at a Chinese bank said.

"Some clients were considering liquidating their dollar positions to stop loss. The next key level might be around 6.78 per dollar level," the trader said.

'RELATIVELY FRAGILE'

Financial News, a newspaper owned by the PBOC, said in a front page commentary on Thursday that adopting measures to stabilise expectations for financial markets and boost confidence is a good idea at a time when investor confidence was "relatively fragile".

"And it is more important to let the market understand that the Chinese economy has showed good and stable momentum, which would provide a solid base for stabilising development in the future," the paper said.

Traders last week said major state-owned banks were selling dollars in the onshore market - a move sometimes interpreted as part of the government's efforts to prop up the yuan.

On Thursday, the yuan midpoint was fixed at 6.8090 per dollar, lifting it 543 pips from the previous day's rate to its strongest level since Nov. 10.

Zhou Hao, an economist at Commerzbank in Singapore, said the administrative measures and market intervention could help stabilise the onshore and offshore yuan exchange rates, but there was "little fundamental support" for a stronger yuan.

"We still believe USD-CNY will spike up eventually," he said in a note. (Additional reporting by Yawen Chen in Beijing; Editing by Richard Borsuk)