The yuan fell sharply against the dollar in the offshore forwards market on Tuesday and one-year dollar/yuan volatilities hit a fresh post-revaluation high after an aggressive monetary tightening by China's central bank.
Traders said the market was looking ahead to a possible global strengthening of the dollar in the second half of this year, after US Federal Reserve chairman Ben Bernanke on Monday again warned about inflation and pledged to "strongly resist" expectations for inflation from becoming permanent. In addition, there is growing uncertainty about China's commitment to long-term yuan appreciation against the dollar.
The Chinese central bank's announcement of a one percentage point rise in commercial banks' reserve ratios, twice as large as the market had expected, suggested to some that authorities might start relying more on domestic monetary policy and less on exchange rates to fight inflation.
"The market is still looking for yuan appreciation against the dollar in the near term, with the possibility of it breaching the psychologically important 6.90 level in coming weeks," said a dealer at a major European bank in Shanghai. "But the prospects for long-term yuan appreciation have become increasingly uncertain."