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SHANGHAI: China's yuan briefly touched a fresh two-week high against a weaker dollar on Thursday before giving back all the intraday gains, dragged lower by a softer-than-expected official midpoint fixing and heightened worries over an economic slowdown.

The Chinese port city of Tianjin reported more COVID-19 infections on Thursday as it stepped up efforts to rein in an outbreak that has spread the highly transmissible Omicron variant to another Chinese city.

Omicron has brought fresh challenges to China's strategy to quickly extinguish local outbreaks, and there are concerns that tough measures taken could end up hampering the economy.

Yuan hits 2022 high against weaker dollar, but upside seen limited

Prior to market opening, the People's Bank of China (PBOC) lifted the midpoint rate to a more than one-month high of 6.3542 per dollar, 116 pips, or 0.18%, stronger than the previous fix of 6.3658. It was the firmest since Dec. 9, 2021.

However, it was weaker than market projections, and 77 pips softer than Reuters' estimate of 6.3465.

In the spot market, the onshore yuan opened at 6.3580 per dollar, rose to a two-week high of 6.3566, before changing hands at 6.3618 by midday, 30 pips weaker than the previous late session close.

The weaker-than-expected official midpoint guidance prevented the market from testing new highs in the yuan, traders said, as some investors suspected the authorities were signalling reluctance to see one-way bets on the yuan becoming too strong.

For now, though, seasonal corporate demand for the yuan ahead of the long Lunar New Year holiday should underpin the Chinese currency, traders said.

Separately, downward pressure on the yuan could emerge as expectations increase for more monetary easing by China at a time when the United States and other major economies appear poised to raise interest rates.

Policy insiders and economists told Reuters that China's central bank is set to unveil more easing steps to support slowing growth, though it will likely favour injecting more cash into the economy rather than cut interest rates too aggressively.

"Although the Omicron outbreak and lower CPI inflation in recent months may increase the likelihood of a slight cut in the PBOC's policy rates in the near term, we believe space remains quite limited, and the impact of a rate cut may also be quite small, especially if the long-term LPR is not revised down," said Lu Ting, chief China economist at Nomura.

Lu expects the PBOC to deliver 50 basis points of a universal reserve requirement ratio cut in the first half of this year and to accelerate its net foreign currency purchases from commercial banks in order to stop the yuan from appreciating too fast, to increase FX reserves and to add liquidity to the economy, which is slowing at "a worrisome pace".

New bank lending in China fell more than expected in December from the previous month, while inflation pressure eased during the same period.

China is scheduled to release fourth quarter gross domestic product data and other indicators of economic activity on Jan. 17, when it is also expected to roll over maturing medium-term lending facility (MLF) loans.

By midday, the global dollar index stood at 94.988, while the offshore yuan was trading at 6.3667 per dollar.

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