Yuan flat as markets seek direction on Europe woes

SHANGHAI: The yuan was flat by midday on Monday despite a stronger midpoint fixing by the central bank, as traders waited for further cues on how economic uncertainties in Europe will play out in the Chinese currency.

The People's Bank of China (PBOC) allowed the yuan to post a historical record monthly decline against the dollar in May, guiding the official midpoint down 1.1 percent over the course of the month.

Part of the reason for guiding the yuan down against the dollar appears to be that, with the euro hit by the sovereign debt crisis in the euro zone, the yuan is trading around its strongest level against the euro since early 2002, posing a challenge for Chinese exporters.

Europe accounts for more than a fifth of Chinese exports -around 16 percent if the United Kingdom is excluded - which some analysts say has given the PBOC an incentive to push the yuan down slightly against the dollar, so as to prevent it from rising further against the euro.

However, Perry Kojodjojo, FX strategist at HSBC, said Beijing has not yet turned to currency policy to support Chinese exports.

"There is no doubt that China is worried about the European issue," he said. "But I don't think FX is their first point of attack to support exports. They have done other measures such as reducing taxes on the export sector, but they are also allowing the currency to adjust to react to the situation in global markets. Europe is looking poor, the dollar is strengthening, so the authorities are letting the renminbi appreciate against the euro."

Traders say the PBOC usually uses the dollar index as a loose reference when setting the midpoint. A research note by Standard Chartered said the correlation between moves in the dollar index and moves in the midpoint has tightened in recent months.

"Since the mid-June 2010 de-peg, the share of the (percentage) move in DXY reflected in the (percentage) move in the fix has been very modest - roughly 0.1 percent. Since early April, this share has been on an upward path and has risen to around 0.4 percent in recent weeks."

The yuan-euro official fixing has also grown more tightly correlated since May, mirroring the dollar fix inversely.

The central bank set the dollar-yuan midpoint at 6.3276 on Monday morning, slightly stronger than its setting on Friday, but the spot rate ignored the fixing and stayed well within the range it traded on Friday, remaining tightly range-bound between 6.3685 and 6.3639 by midday.

A trader at a Western bank in Shanghai said markets were stable at current levels, awaiting new developments.

"So far there is good buying interest in buying euro-crosses, especially euro-China, but once the European markets open, depending on the performance there might be more risk-off sentiment and dollar buying," he said.

Yuan 1-year non-deliverable forwards also stayed flat, implying depreciation around 1.5 percent.

The offshore yuan (CNH) continued to track the onshore yuan but maintained its trend of trading slightly weaker than the onshore spot, which may be related to tightening liquidity in the CNH market. The supply of offshore yuan continued to contract in April, and has now shrunk for five consecutive months.