The yuan strengthened against the dollar on Friday and scored its second biggest daily gain since its revaluation two years ago, amid signs that the Chinese central bank was prepared to permit it to rise further.
The yuan ended at 7.5666, up 0.27 percent from Thursday's close of 7.5870 - its second largest daily percentage rise since its peg to the dollar was abolished in July 2005.
The surge came after the central bank set a much stronger daily yuan mid-point of 7.5691 for Friday, up 0.21 percent from Thursday's mid-point. It was the mid-point's biggest daily gain since July 10, and the fourth-largest since the revaluation.
"The prospects for the yuan to breach its post-revaluation trading peak have suddenly brightened after the central bank signalled more willingness to allow the yuan to rise for now," said a Shanghai dealer at a US bank.
"The breach should occur some time next week." The yuan's traded peak since its revaluation is 7.5543, reached on July 25. Through its use of the mid-point, the central bank effectively blocked yuan appreciation for six weeks through Wednesday, apparently because it wanted to see if the US subprime loan crisis hurt the global economy and Chinese exports.
Its much higher mid-point on Friday seemed to signal that it had become confident enough of the global outlook to let appreciation resume, traders said. Earlier this week the central bank hiked interest rates to fight inflation, and a strong yuan would help its effort.
However, longer-term offshore non-deliverable forwards showed a drop in expectations for yuan appreciation on Friday - suggesting many dealers remained uncertain of the central bank's intentions. One-year dollar/yuan NDFs edged down to 7.1960/2000 in late trade on Friday from 7.2040/80 late on Thursday.
This implied yuan appreciation from Friday's mid-point of between 5.13 and 5.18 percent in a year's time, down from Thursday's implied 5.23-5.28 percent. A couple of weeks ago, implied appreciation was above 6.0 percent. "Although the market now expects the yuan to resume a steady rise in the near term, the murky central bank decision-making process always makes the yuan trend very difficult to predict," said a dealer at a major Chinese state-owned bank.
Some dealers think the central bank is deliberately trying to confuse the market in order to introduce greater two-way volatility into trade, which is one of its goals as it develops the foreign exchange market.