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China Sets Yuan Above Hong Kong Dollar Peg

China's central bank set the yuan's mid-point against the U.S. dollar on Thursday above parity with the Hong Kong dollar's peg to the U.S. dollar for the first time.

The People's Bank of China set the day's yuan mid-point at 7.7977 to the U.S. dollar, up from Wednesday's close of 7.8071.

The Hong Kong dollar is pegged at 7.8 to the U.S. dollar, although it can trade between 7.75 and 7.85. It was quoted at 7.7950/60 in the morning session Thursday.

It was the first time the yuan had breached parity with the peg since China unified its dual exchange rate system in 1994 and launched its domestic foreign exchange market, the China Foreign Exchange Trade System.

Appreciation of the yuan toward parity with the peg in recent months had fuelled speculation that Beijing might consider having Hong Kong abandon the peg, possibly even unifying the yuan and the Hong Kong dollar.

But Hong Kong officials have said repeatedly that breaking parity would have no impact on the territory's monetary policy. Financial Secretary Henry Tang, however, conceded it might have a "psychological" impact on markets.

Some traders and analysts said the main impact of the move through 7.8 might be on the dollar/yuan rate. China's willingness to have the rate move through that sensitive level suggests it may now be prepared to see another round of yuan appreciation against the dollar, they said.

"Dollar/yuan was set lower -- below 7.8 -- today despite a very strong dollar overnight. I think this suggests another sharp downturn in dollar/yuan going forward," said Qing Wang, currency strategist at Bank of America in Hong Kong.

"Breaking the 7.8 level is definitely a moment people are looking for with some anxiety, but I don't think there will be any material impact on the Hong Kong market."

In the morning session Thursday, the yuan rose as high as 7.7955 to the dollar. "I think the implication is on the yuan, especially as this central parity was set one day after Chinese authorities released trade numbers showing a very large trade surplus," Wang said.

"I think China will allow faster appreciation of the currency this year. Our forecast is that the yuan will appreciate 4-6 percent in 2007, instead of about 3.5% seen in 2006."

Bank of America's forecast is in line with a general consensus in the Shanghai foreign exchange market for appreciation of about 5% this year. China announced on Wednesday that its trade surplus last year jumped 74% to a record $177.47 billion.