SHANGHAI: China's yuan weakened slightly on Friday, trading within a hair's breadth of lower limit of the official daily trading band, as central bank has limited the yuan's decline against a dollar that has gained sharply against other major currencies.
The People's Bank of China set the midpoint rate at 6.137 per dollar prior to market open, weaker than the previous fix 6.1335, putting it on course to end the week down over 0.3 percent.
The spot market opened at 6.2510 per dollar and was changing hands at 6.2507 at midday, 38 pips away from the previous close and 1.85 percent away from the midpoint. The spot rate is currently allowed to trade with a range 2 percent above or below the official fixing on any given day.
The dollar has advanced nearly 20 percent against a basket of traded currencies since July.
By setting the daily midpoint close to 2 percent stronger than the spot rate's trend, the central bank effectively limits the rate of the yuan's decline.
Aside from casting doubt over China's commitment to letting market forces determine the exchange rate, there is also the risk that market could dry up if banks refuse to trade in the range the central bank sets.
That caused repeated flatlines in the market in late 2012 and 2013, as banks sat on the sidelines and waited for the central bank to adjust its midpoint to a range they thought more reasonable.
Some analysts are calling for Beijing to widen the trading band again, but others note that the width of the band is irrelevant if the midpoint is fixed at levels that market perceives as unrealistic.
The offshore yuan was trading 0.17 percent below the onshore spot at 6.2615 per dollar.
Offshore one-year non-deliverable forwards contracts (NDFs), considered the best available proxy for forward-looking market expectations of the yuan's value, traded at 6.3635, 3.56 percent below the midpoint.
One-year NDFs are settled against the midpoint, not the spot rate, and now that the trading band has been widened to 2 percent in either direction, corporates are much warier of using the NDF to hedge given the basis risk inherent in them.
As a result the market has lost liquidity in recent years and has frequently proven an unreliable measure of market sentiment.
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