SHANGHAI: China's yuan fell sharply in early trade on Wednesday to its lower daily limit against the dollar, although it later recovered somewhat, reflecting worries among traders about the potential fallout from the US Senate passing a bill aimed at pushing China to let its currency rise at a faster pace.
The People's Bank of China has at times in the past engineered falls in the yuan to coincide with US pressure for it to strengthen its currency, in what analysts have interpreted as an attempt to signal that it will move at its own pace on the yuan, also known as the renminbi.
Expectations that it could take a similar response to the move from the US Congress led to a sharp fall in the yuan in the opening minutes of trade, pushing it briefly to the bottom end of the daily trading band at 6.3916, even though the PBOC had set the day's mid-point higher than Tuesday's close.
The yuan later trimmed its losses to stand at 6.3806 per dollar as of 0315 GMT, down only slightly from Tuesday's close.
It saw a similar move in the offshore market, falling sharply in early trade to as low as 6.5530 per dollar as companies unwound long yuan positions, but then rising back to 6.4700 by 0315 GMT.
"Since a sort of panic prevailed in early trading, the Big Four state banks were seen offering dollar liquidity to the market that then helped the yuan to move away from its limit-down level," said a trader at a US Bank in Shanghai.
"This is actually not a surprise as the PBOC and the Big Four are the only sources of dollar liquidity in the domestic market."
Under China's capital account controls, the central bank and other designated banks buy the bulk of dollars flowing into the country to keep a grip on the yuan's exchange rate.
NO SIGN OF RETALIATION - YET
Currency politics have hung over the local currency market this week, as the US Senate late on Tuesday approved a controversial bill aimed at imposing penalties for what it says is an undervalued yuan that is hurting the American jobs market.
While that bill would have to pass the House of Representatives and be signed by President Barack Obama to become law, China wasted no time in responding to it, with the foreign ministry issuing a strongly worded statement just hours after its passage, and the central bank following up by saying the currency was not the main cause of trade imbalances.
Still, the PBOC set its mid-point against the dollar at 6.3598, shy of a record high the day before at 6.3375 and still stronger than the close in the spot market on Tuesday.
The central bank uses the reference rate, from which the dollar/yuan exchange rate may rise or fall 0.5 percent each day, to signal the government's intentions for the yuan.
"Market jitters over a potential trade dispute between the United States and China loom very large, although the PBOC did not give an indication of an immediate retaliation via its mid-point," said a trader with a major European bank.
"Past experience shows that excessive US pressure on China for yuan appreciation is temporarily counterproductive, with China often halting yuan appreciation for a while to show resistance to what it thinks is interference in its internal affairs."
Spot yuan has now appreciated 3.3 percent since the start of this year and 7.0 percent since it was depegged from the dollar in June 2010.
Despite the latest war of words, traders said they did not expect China to take retaliatory action unless the bill actually becomes law.
Many traders still expect the yuan to reach somewhere between 6.2 and 6.3 against the dollar by the end of this year, meaning it could rise about 5 to 6 percent for all of 2011.
Copyright Reuters, 2011
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