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Yuan pulls up from 1-month low as traders weigh PBOC's tolerance for losses

SHANGHAI, Sept 27 (Reuters) - China's yuan fell to its weakest level in nearly a month on Wednesday but recouped its losses by midday as the market grew nervous over how much further the central bank will allow the currency to weaken. Since hitting a 21-month high on Aug. 8, the yuan had lost more than 2,000 pips through Wednesday morning. Many traders believe the reversal is a sign that authorities were growing increasingly worried about the potential economic impact from the yuan's recent rapid gains, particularly on exports. But some China watchers believe the correction may now be nearing its limits, especially as authorities will want to keep the yuan relatively stable in the run-up to a key Communist Party meeting starting on Oct. 18. Prior to the market opening on Wednesday, the People's Bank of China lowered its official yuan midpoint for the third day in a row to 6.6192 per dollar, the weakest level since Aug. 29, reflecting a softer spot yuan on the previous day and gains in the dollar. Wednesday's official guidance was 116 pips or 0.18 percent weaker than the previous fix of 6.6076 on Tuesday. Market participants said the official fix was below their forecasts, as it was on Tuesday, suggesting that authorities may be willing to let the yuan slide further. In the spot market, the yuan opened at 6.6359 per dollar and fell to a low of 6.6422 at one point, the softest level since Aug. 28. Traders reported heavy dollar demand from both companies and households, adding to the pressure. Bank clients usually shore up their dollar positions ahead of the week-long National Day holiday starting on Oct.1. But the sharp loss in spot yuan soon made the market nervous about the potential for intervention. As of midday, the yuan was changing hands at 6.6341, 59 pips firmer than the previous late session close but 0.23 percent softer than the midpoint. "We believe that the PBoC would likely tolerate RMB depreciation at this level to achieve the two-way volatility trading but would turn more cautious if the CNY tested 6.65 level," said Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong. The 6.7 per dollar level would likely be a line in the sand for the authorities, Cheung added. The Thomson Reuters/HKEX Global CNH index, which tracks the offshore yuan against a basket of currencies on a daily basis, stood at 95.43, firmer than the previous day's 95.31. The global dollar index rose to 93.081 from the previous close of 92.966. The offshore yuan was trading 0.08 percent firmer than the onshore spot at 6.6287 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 6.7775, 2.34 percent weaker than the midpoint. One-year NDFs are settled against the midpoint, not the spot rate.

The yuan market at 0425 GMT:

ONSHORE SPOT:

Item Current Previous Change PBOC midpoint 6.6192 6.6076 -0.18% Spot yuan 6.6341 6.64 0.09% Divergence from 0.23%

midpoint*

Spot change YTD 4.71% Spot change since 2005 24.76%

revaluation

Key indexes:

Item Current Previous Change Thomson 95.43 95.31 0.1

Reuters/HKEX CNH index

Dollar index 93.081 92.966 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 6.6287 0.08% * Offshore 6.7775 -2.34%

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. .

(Reporting by Winni Zhou and Andrew Galbraith; Editing by Kim Coghill)