China finally bowed to two years of political and market pressure on Thursday by revaluing the yuan by 2.1 percent and leaving the door open to further rises by abandoning the currency's decade-old peg against the dollar.
Analysts described the long-awaited move as modest and said it would have a limited economic impact. But they said the shift, ahead of a US visit in September by President Hu Jintao, made good political sense and potentially marked a critical step by China's policy makers toward giving more play to market forces.
"The most important thing is the change, not how much it changed," said Li Yang, a senior economist with the Chinese Academy of Social Sciences in Beijing.
US Treasury Secretary John Snow applauded the shift as a significant contribution to global financial stability, while a senator who has been a leading critic of Beijing's currency policies called it a welcome "first baby step".
"If there are not larger steps in the future, we will not have accomplished very much. But after years of inaction, this step is welcome," Sen. Charles Schumer, a New York Democrat, said in a statement.
After keeping the yuan virtually fixed near 8.28 per dollar since 1996, China said that as of 7 pm (1100 GMT) it was adjusting the currency's value to 8.11 and tying it to a basket of currencies of China's main trading partners.
The central bank said the yuan would be allowed to move in a tight range of 0.3 percent up or down from the previous day's close - the same flexibility China has had, but chosen rarely to use, since it adopted a "managed float" policy in 1994.
The Japanese yen leapt 2 percent on speculation other Asian governments, afraid until now of giving China a competitive edge, would let their currencies rise on the yuan's coat-tails.
Malaysia promptly did just that, scrapping the peg that had frozen the ringgit since 1998 and switching like China to a managed float. But Hong Kong, whose currency is also fixed against the dollar, said it had no intention of changing policy.
With China's initial revaluation falling well short of the 10 percent move that Washington had been seeking, dealers immediately started to wonder whether this would be the first in a series of gradual moves.
"It's just a gesture. The question now is whether there will be continuing speculation that China may revalue even more," said Ben Kwong, an analyst from KGI Asia in Hong Kong.
Frank Gong, chief economist for J.P. Morgan Chase in Hong Kong, said he expected the yuan to climb 10 percent over the next year.
But a spokesman for the central bank said big movements in the yuan would harm the economy, which has become a major engine of world growth since China threw its markets wide open by joining the World Trade Organisation in 2001.
China had long insisted that it would adopt a more flexible exchange rate system, but not until it was ready.
In March Premier Wen Jiabao impishly said the timing of a move would be a surprise and has since reacted testily to calls for a shift, saying the question touched on China's sovereignty.
Foreign pressure has been especially intense in the United States, where many law-makers blamed their country's $162 billion 2004 trade deficit with China on an artificially cheap yuan, which they said handed Chinese exporters an unfair advantage.
Schumer is co-author of a bill that would have slapped a 27.5 percent tax on Chinese imports if Beijing did not revalue.
Last month he delayed a vote on the measure after Snow and Federal Reserve Chairman Alan Greenspan said it would be counterproductive politically.
"It maybe relieves the pressure from the US with tariffs on the table in Congress, but it remains to be seen if it is enough politically and economically. It is not going to change the trade position," said Mark Cliffe, chief economist at ING in London.
Greenspan, too, has said a yuan revaluation would have minimal impact on the US trade deficit, but he and others had urged China to adopt a more flexible currency for its own sake.
Economists said the money from China's fast-growing trade surplus, on top of heavy speculative inflows of capital betting on a revaluation, had been making it harder for China to manage its monetary policy and would eventually stoke inflation.
To keep the yuan's exchange rate fixed, China has had to buy up huge quantities of dollars. Its foreign exchange reserves swelled to $711 billion at the end of June, the world's largest stockpile after Japan's. Much of the money has been invested in US bonds, helping to keep US interest rates low.
The central bank said the shift would improve the running of the economy because the exchange rate would be more flexible and would respond to market supply and demand.
"The People's Bank of China will make adjustment of the RMB exchange rate band when necessary according to market development as well as the economic and financial situation," the central bank said in a statement in English on the web site.
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