China's yuan closed weaker against the dollar on Friday, as the central bank guided the yuan lower in response to the US currency's overnight strength on global markets, dealers said. The yuan finished at 7.7280 to the dollar, down from Thursday's close of 7.7266.
The yuan bounced smartly from its early low of 7.7345, however, touching an intraday high of 7.7277 late in the session on rising expectations that the central bank might soon raise interest rates again.
The market showed little reaction to a narrowing of the spread of the two currencies' money market rates, which hit its lowest level since the yuan's 2005 revaluation, amid signs that the central bank has increasingly focused on interest rates instead of the exchange rate.
Before the start of trading, the central bank set the yuan's daily mid-point at 7.7359, weaker than Thursday's 7.7310, which was the strongest mid-point since the yuan was revalued and depegged from the dollar in July 2005.
The central bank's mid-point serves to direct the yuan's daily movements, and while it has been kept in line with the central bank's overall objective of a stable currency, its day-to-day value has recently been increasingly in line with the dollar's global moves, dealers said.
The dollar steadied against the euro and yen on Friday, retaining gains scored in the previous session on views that the Federal Reserve may keep interest rates on hold for some time.
"Recently, the central bank appears to be setting the yuan's daily mid-point simply in line with global dollar movements, as it shifts its focus to domestic monetary policy adjustments," said a Shanghai dealer at a European bank.
"That trend is likely to continue in the coming months," he said. Last Sunday, the central bank raised its benchmark deposit and lending rates by 0.27 percentage point, while over the past three weeks it has persistently guided money market rates higher, through stronger yields than the market had expected in bill auctions in its regular open market operations.
The auction results caused the spread between the one-year Chinese central bank bill yield in the secondary market and one-year US dollar LIBOR to shrink to 222 basis points on Thursday, its lowest since the yuan revaluation. Friday's LIBOR rates will be calculated later in the day.
Although the narrowing gap will add pressure on the yuan to appreciate, the currency's gains have actually slowed since early February, suggesting that the central bank has become less keen to allow the yuan to rise than it was in January.
The yuan has gained 0.39 percent since February 1, for an annual appreciation rate below 3 percent, compared with 0.6 percent in January, for an annual rate of 7 percent. Still, dealers said the People's Bank of China was likely to allow the yuan to rise a bit faster in the coming months, to forestall arbitrage opportunities that might emerge from the combination of a slower yuan rise and surging money market rates.
On Friday, the discount of one-year onshore yuan/dollar swaps reached 1,822 pips, the lowest since December 8, 2006, when it hit 1,815 pips, according to figures posted on the Web site of the China Foreign Exchange Trade System.
That increases the potential gains from arbitrage against the 2.9670 percent yield of the central bank's one-year bills traded on the secondary market, as indicated by Reuters Reference Rates.
The offshore non-deliverable forward market also continued to forecast strong yuan gains in the longer term. One-year NDFs quoted the yuan at 7.2570/7.2620, indicating appreciation between 6.53 and 6.60 from Friday's yuan mid-point in a year's time. The NDFs showed appreciation of 6.13 to 6.20 percent last Friday and 5.19 to 5.27 percent at the end of last year.