SHANGHAI, May 22 (Reuters) - China's yuan inched lower against the dollar on Wednesday, but the overall downward pressure on the local currency was mild as the central bank signaled its determination to prevent any sharp falls. The yuan has dropped more than 2.5 percent since U.S. President Donald Trump said on May 5 he will raise tariffs on $200 billion of Chinese imports to 25% from 10% previously, in a major escalation of a trade dispute between the two economic giants. The higher tariffs took effect on May 10. On Tuesday night, the People's Bank of China (PBOC) said it will issue yuan-denominated bills in Hong Kong in the near future, which analysts said was designed to tighten offshore liquidity to stabilise the weakening currency. Prior to market opening on Wednesday, the PBOC set the midpoint rate at 6.8992 per dollar, 2 pips weaker than the previous fix of 6.8990. Traders said the fixing yet again came in much firmer than their models had suggested in a sign of Beijing's determination to flush out any entrenched yuan bears. Wednesday's midpoint was 72 pips firmer than Reuters' estimate of 6.9064. In the spot market, onshore yuan opened at 6.9060 per dollar and was changing hands at 6.9089 at midday, 61 pips weaker than the previous late session close and 0.14 percent softer than the midpoint. Frances Cheung, head of macro strategy for Asia at Westpac in Singapore, said central bank's intention to sell bills in Hong Kong could increase the cost of establishing bearish yuan positions offshore. "PBOC bill is a monetary policy tool, the issuance of which in the offshore market absorbs CNH liquidity. The announcement of the supply came at a time when the PBOC has shown its intention to maintain RMB stability and prevent rapid depreciation," she said. The PBOC sold 20 billion yuan ($2.89 billion) of bills in Hong Kong last Wednesday, when front-end borrowing costs surged in the financial hub on the same day. Stephen Chiu, currency and rates strategist at China Construction Bank (Asia) in Hong Kong, said the bill sales would lift the CNH Hong Kong Interbank Offered Rate benchmark (CNH Hibor) on the bill auction day. "It will be effective as in temporarily suppressing the USD/CNH rise but eventually would need the U.S. and China to make peace in order for the RMB selling pressure to go away," Chiu said. Although the PBOC did not give further details on the bill sales, Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong said he reckoned that "the tenor would be shorter than three months if the PBOC intended to drain excess offshore RMB liquidity in order to effectively raise carry cost of short CNH spot position." The dollar index, a measure of the greenback against a basket of its peers, hovered a near 3-1/2-week high, trading at 98.015 as of midday. The offshore yuan was trading at 6.933 per dollar at mdiday.
The yuan market at 0400 GMT:
Item Current Previous ChangePBOC midpoint 6.8992 6.899 0.00%Spot yuan 6.9089 6.9028 -0.09%Divergence from 0.14%
Spot change YTD -0.52%Spot change since 2005 19.79%
Item Current Previous ChangeThomson 93.92 93.8 0.1
Reuters/HKEX CNH index
Dollar index 98.015 98.062 -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 6.933 -0.35%*Offshore 6.9712 -1.03%
*Premium for offshore spot over onshore
**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. .
($1 = 6.9089 Chinese yuan)
(Reporting by Winni Zhou and John Ruwitch Editing by Shri Navaratnam)