×

Yuan ends week on firm footing as market ponders PBOC moves

SHANGHAI, June 2 (Reuters) - The Chinese yuan ended a holiday-shortened week just off seven-month highs, jumping sharply higher after China's central bank took aggressive steps to prop up the currency, a move that has left traders and analysts guessing at its motivations.

The People's Bank of China (PBOC) already took markets by surprise last week when it announced it would add an as-yet undefined "counter-cyclical" factor to its daily reference point calculations to overcome depreciation expectations.

The yuan ended at 6.8162 per dollar on Friday, up 0.5 percent over the week, a rare spurt for a currency that usually trades in a wafer-thin range. Those heights were reached after the PBOC set the yuan midpoint at 6.8090 per dollar on Thursday, the strongest level since Nov. 10.

The PBOC set the midpoint rate on Friday at an even stronger 6.8070 per dollar.

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's rapid ascent had caught traders off guard. A Reuters poll of more than 50 foreign exchange analysts taken this week forecast that the yuan would weaken an additional 3-5 percent this year after a 6.5 percent drop in 2016. The currency has risen about 2 percent since the beginning of the year.

Coming after a period of relative stability, traders and economists searched for reasons behind the timing and purpose of the central bank's strong midpoint fixing.

Some pointed to a downgrade of China's sovereign credit rating by Moody's Investors Service last week as a contributing factor.

"After the downgrade decision by Moody's, the mainland government wanted to squeeze liquidity. They don't want speculators to attack the currency," said one trader at a local bank in Hong Kong.

Others said the yuan's rise and the change in the central bank's daily fixing mechanism may pave the way for a degree of currency liberalization.

While lessening the impact of the currency's daily close on the next day's fixing, the moves "may also reflect the policy intention to have the RMB trade with greater two-way volatility, which is easier to introduce during a soft USD environment," HSBC foreign exchange strategists wrote in a note Friday.

The PBOC may have also seen the opportunity posed by a softer dollar to raise the value of the yuan preemptively.

"We are really in speculation territory...but now that we are in a period where they don't need to do so much firefighting, they have some time to think about preparing for future pressures," said Louis Kuijs, head of Asia economics at Oxford Economics.

The central bank did not respond to faxed questions from Reuters.

OUTFLOW CONCERNS

A new regulation announced on Friday by the foreign exchange regulator underscored that Beijing remains concerned about the risks posed to its currency by capital outflows.

The State Administration of Foreign Exchange said that Chinese banks would be required to report daily on bank card holders' overseas transactions exceeding 1,000 yuan ($146.7)

While capital outflows from China dropped sharply in the first quarter and even reversed in April, the PBOC continues to want to manage market expectations, said an economist at a bank in Shanghai, who declined to be identified because he was not authorized to speak publicly on central bank policy.

Strong expectations that the U.S. Federal Reserve will boost interest rates in June may increase that pressure, and Moody's downgrade, while not influential among domestic investors, may worsen overseas investors' bearish view of the Chinese currency.

"All of these are potential pressure to trigger the next round of capital outflows," the economist said. (Editing by Jacqueline Wong)