China's yuan jumped against the dollar in early trade on Wednesday to its highest since its 2005 revaluation after the central bank set a much higher reference rate for the Chinese currency.
Traders said sharp swings over the past week in the central bank's mid-points, which set the parameters for each day's trade, were apparently aimed at making the market accustomed to greater volatility.
Creating a more active foreign exchange market is a long-standing policy goal.
The yuan was trading at 7.6271 to the dollar in the Asian morning session, up 0.22% from Tuesday's close of 7.6436.
If the yuan closes at Wednesday's morning's level, it will record its third-biggest daily rise since Beijing revalued the currency and abolished its peg to the dollar in July 2005.
Before trade began, the central bank set its daily mid-point at 7.6282, a 0.25% rise from Tuesday's mid-point and the second-largest single-day rise in the mid-point -- trailing only Tuesday's 0.41% jump. Tuesday's mid-point prompted the yuan's biggest daily gain in trading since the revaluation.
Between last Thursday and Monday, however, the central bank used the mid-point to engineer a sharp 0.36% fall in the yuan against the dollar, on a closing basis.
"The central bank is testing the waters for more flexibility in the yuan's exchange rate movements," said a Shanghai dealer at a European bank.
Dealers said the sudden reversal of the trend on Tuesday and Wednesday also coincided with rising U.S. pressure on China to boost its currency.
Pressure On Appreciation
Four U.S. senators plan to unveil a bill in Washington on Wednesday aimed at forcing faster yuan appreciation, the same day the U.S. Treasury Department will issue a report on the foreign exchange practices of key trade partners including China.
"A more flexible yuan will allow China to make goodwill gestures during politically sensitive periods," said a Shanghai dealer at a North American bank. "But we don't expect the yuan to quicken its pace of appreciation for all of 2007."
Traders said they left their forecasts for yuan appreciation unchanged at 4 or 5% for all of 2007, compared with 3.4% last year.
Wednesday's offshore non-deliverable forwards showed a weakening of expectations for yuan appreciation despite the jump in the domestic spot market.
One-year NDFs quoted the yuan at 7.2850/7.2900, indicating appreciation of 4.64 to 4.71% in one year's time from Wednesday's mid-point. That was down from 4.88 to 4.95% on Monday, and 6.55 to 6.62% in late March.
In the long run, China's central bank would find it easier to engineer faster yuan appreciation in a more volatile, two-directional market.
There are no indications, however, regarding if or when a decision to accelerate appreciation will be made, dealers said.
In addition to external pressure, China also finds itself in need of a stronger yuan to solve its own economic problems, such as a huge trade surplus and rising inflation, dealers said.
Official data show China's trade surplus jumped to $22.45 billion in May, much higher than economists' expectations of $18.8 billion. The country's consumer price inflation hit a 27-month high of 3.4% in May, fuelling speculation about another interest rate hike in coming days or weeks.