China's yuan closed lower against the dollar on Friday as market expectations of a quicker pace of yuan appreciation, fuelled by the prospects of an interest rate hike, were dampened when the central bank set a weaker mid-point, dealers said.
China's consumer prices rose 3.3 percent from a year earlier in March, the National Bureau of Statistics said on Thursday, confirming a rumour that had swirled in the market for more than a week and sparking speculation that the central bank would soon raise official interest rates again after an increase in March.
An interest rate hike would narrow the current gap of 2.46 percentage points between China's one-year yuan deposit rate and the one-year US dollar LIBOR, inviting speculative fund inflows that would add pressure for the yuan to rise, dealers said.
In the offshore non-deliverable forwards market, one-year non-deliverable forwards quoted the yuan at 7.2620/7.2670, indicating appreciation of 6.27 to 6.35 percent from Friday's mid-point in a year's time. The figures were up sharply from 6.09 to 6.14 percent on Thursday.
The central bank set the yuan's daily mid-point at 7.7230 versus the dollar before trading began on Friday, down from a mid-point of 7.7199 on Thursday, the highest since the yuan was revalued and depegged from the dollar in July 2005.
"Signs again indicate that the pace of exchange rate changes may not necessarily be in line with interest rate movements in a largely closed foreign exchange market like China's," said a Shanghai-based dealer at a European Bank.
"More likely, the central bank could even tighten its control over the pace of yuan appreciation when it focuses on the interest rate regime," he said. The yuan closed at 7.7179 to the dollar, near an intraday high of 7.7170, compared with Thursday's close of 7.7165. Expectations of an interest rate hike helped to push the Chinese currency to an intraday high on Thursday of 7.7160, its highest since the revaluation.
On Friday, the yuan touched an intraday low of 7.7222 and never traded lower than the central bank's mid-point of 7.7230, indicating the market was at odds with the central bank on the near-term trend of the yuan's exchange rate, dealers said.
"The central bank had apparently used today's mid-point to cool speculation of faster yuan gains," said a dealer at a US bank. "Although the market disagreed with the mid-point, the central bank still has the final say on the yuan's future rise." Chinese rules decree that the yuan must not rise or fall more than 0.3 percent from the central bank's mid-point each day.
Friday's yuan trading contrasted with banks' routine willingness since early February to quote the yuan at rates weaker than the mid-point, reflecting concerns over China's rising inflation and a fall in the March trade surplus.