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China's yuan gains, but market wary of Beijing's currency policy

SHANGHAI, July 5 (Reuters) - China's yuan strengthened against the dollar on Wednesday as greenback sales by major state-owned banks eclipsed corporate demand for it, though traders were wary of the outlook amid uncertainty over Beijing's policies on the local currency. The People's Bank of China (PBOC) fixed the yuan midpoint lower for the third day in a row on Wednesday to 6.7922 per dollar prior to the market opening, weaker than the previous fix at 6.7889. In the spot market, the yuan opened at 6.7995 per dollar, and then rose to a high of 6.7923 before retreating to 6.7952 at midday, 53 pips firmer than the previous late session close but 0.04 percent weaker than the midpoint. Traders said corporate dollar demand remained strong on Wednesday, but most market participants were cautious due to recent volatility in the Chinese yuan and dollar sales by state banks. On Wednesday, multiple traders said they saw major state-owned banks selling dollars in the market to prop up the yuan, as happened on Tuesday. This trend by state-owned banks has persisted over the past two months in what traders believe is part of official efforts to stabilize the Chinese currency and flush out overly bearish yuan bets. "The spot yuan movement in the near term largely depends on the authorities' attitude, rather than the performance of the U.S. dollar," a Shanghai-based trader at a Chinese bank said. The months of June and July are usually characterized by high corporate dollar demand as some Chinese companies purchase the U.S. currency to pay dividends to their shareholders overseas. Noting that the yuan had strengthened against the dollar in June, Rob Carnell, head of research at ING, said the PBOC has sent strong signals to the market that it "prefers appreciating currency." "We think this could have changed market expectation on the CNY and deferred the speculative capital outflows," Carnell wrote in a note on Wednesday. In the face of entrenched bearish sentiment on the yuan and capital outflow pressures, policymakers stepped up their defense of the currency in the second quarter, including tweaking the way it set the yuan's daily guidance rate. Separately, the PBOC reaffirmed in its second-quarter monetary policy committee meeting that the yuan would remain basically stable and pledged again to continue pushing forward on interest rate and exchange rate reforms. On Tuesday, China's cabinet approved an increase of quota under the Renminbi Foreign Institutional Investor (RQFII) scheme for Hong Kong to 500 billion yuan ($73.59 billion) to further meet demand for yuan asset allocation by Hong Kong investors, the central bank said in a statement on its website.

The Thomson Reuters/HKEX Global CNH index, which tracks the offshore yuan against a basket of currencies on a daily basis, stood at 94.54, firmer than the previous day's 94.52. The global dollar index fell to 96.168 from the previous close of 96.218. The offshore yuan was trading 0.01 percent firmer than the onshore spot at 6.7946 per dollar. 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 6.964, 2.47 percent weaker than the midpoint. One-year NDFs are settled against the midpoint, not the spot rate.

The yuan market at 0410 GMT:

ONSHORE SPOT:

Item Current Previous Change PBOC midpoint 6.7922 6.7889 -0.05% Spot yuan 6.7952 6.8005 0.08% Divergence from 0.04%

midpoint*

Spot change YTD 2.23% Spot change since 2005 21.80%

revaluation

Key indexes:

Item Current Previous Change Thomson 94.54 94.52 0.0

Reuters/HKEX CNH index

Dollar index 96.168 96.218 -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

from onshore

Offshore spot yuan 6.7946 0.01% * Offshore 6.964 -2.47%

non-deliverable forwards

**

*Premium for offshore spot over onshore

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. .

($1 = 6.7947 Chinese yuan)

(Reporting by Winni Zhou and Andrew Galbraith)