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Yuan softens as trade war, credit risks heighten

HONG KONG, May 29 (Reuters) - The yuan eased against the dollar on Wednesday, hovering not far from 5-1/2-month lows, as Sino-U.S. trade tensions saw no signs of cooling and amid concerns over China's ability to stabilize both its debt and foreign exchange markets. U.S. President Donald Trump said on Monday he was not yet ready to make a deal with Beijing, alleging that "businesses are leaving China, by the hundreds, by the thousands, and going into areas that are not tariffed." Hitting back, a Chinese Communist Party newspaper warned the United States on Wednesday the government was ready to use rare earths to strike back on trade, saying in an extremely strongly worded commentary "don't say we didn't warn you." But the yuan was unlikely to swing wildly ahead of the G20 summit in Japan in late-June, where Trump is expected to meet Chinese President Xi Jinping, traders said. "The possibility of a large depreciation (before G20) is low, and at the same time, the renminbi also lacks strong drivers for strengthening," said a trader with a foreign bank in Shanghai. DBS analysts said in a note on Wednesday that it was a "reflief" the Trump administration refrained from labeling China a currency manipulator, but trade uncertainty will still weigh on global currencies before G20. Spot yuan drifted lower for a second consecutive day to 6.9138 per dollar at 0403 GMT, 58 pips softer than the previous late session close and 0.22 percent weaker than the midpoint. It was trading close to lowest point in almost six months, at 6.9217 per dollar, which was breached last Thursday. Investors got some respite after People's Bank of China Governor Yi Gang reiterated the central bank's determination to keep the yuan stable, and also kept the fixing on the strong side of 6.90 per dollar. "If you look at the midpoint, the central bank's attitude (to keep the yuan stable) is very clear," said a second trader in Shanghai. The PBOC set the midpoint rate at 6.8988 per dollar before the open, weaker than the previous fix of 6.8973. Onshore spot can trade 2 percent either side of this point. But analysts at Bank of America Merrill Lynch warned in a note on Wednesday that the PBOC's ability to keep the yuan stable has come under fresh pressure, amid increasing credit risk in the domestic market. Regulators took over troubled lender Inner Mongolia-based

Baoshang Bank this week, lifting interbank financing

costs for some smaller banks and stirring contagion fears.

On Wednesday, sources told Reuters the banking regulator had asked lenders to conduct thorough checks and report their business ties with Baoshang Bank. "The challenge will be how to facilitate this liquidity without allowing the CNY to depreciate too far," the analysts said. The offshore yuan was trading 0.21 percent weaker than onshore spot at 6.9284 per dollar, down 0.1 percent on the day. The global dollar index fell to 97.918 from the previous close of 97.952.

The yuan market at 4:03AM GMT:

ONSHORE SPOT:

Item Current Previous ChangePBOC midpoint 6.8988 6.8973 -0.02%Spot yuan 6.9138 6.908 -0.08%Divergence from 0.22%

midpoint*

Spot change YTD -0.59%Spot change since 2005 19.71%

revaluation

Key indexes:

Item Current Previous ChangeThomson 93.83 93.69 0.2

Reuters/HKEX CNH index

Dollar index 97.918 97.952 0.0*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 6.9284 -0.21%*Offshore 6.9658 -0.96%

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 Noah Sin Editing by Jacqueline Wong)