More yuan supply from liquidity injections by the People's Bank of China (PBOC) have helped push down dollar funding costs in the domestic foreign exchange derivative markets, traders said. Money rates recently spiked due to seasonal demand ahead of the Spring Festival or Lunar New Year holiday next week.
Spot yuan was trading at 6.0525 per dollar at midday, down 0.02 percent from 6.0513 at Wednesday's close after the PBOC set its midpoint 0.03 percent lower at 6.1107 from Wednesday's 6.1087.
The central bank has used its midpoint fix to keep spot yuan largely stable around 6.05 since the start of the year, signalling the government's intention to keep the Chinese currency largely stable, traders said.
Activity in China's factory sector contracted in January for the first time in six months, a preliminary survey showed, but traders said the yuan's movements mainly tracked the central bank's daily midpoint.
Weighed down by weaker domestic and export demand, the flash Markit/HSBC Purchasing Managers' Index (PM) fell to 49.6 in January from December's final reading of 50.5, dropping below the 50 mark which separates expansion of activity from contraction.
In the derivatives markets, one-year dollar funding costs implied in China's dollar/yuan forwards dropped to 3.68 percent on Thursday from 3.77 percent on Wednesday.
One-month dollar funding costs tumbled to 3.41 percent from 3.56 percent. Thursday's data will be published late in the afternoon.
Some dollar funding rates recently reached their highest levels in more than two years as Chinese firms sought dollars ahead of the Lunar New Year to meet possible demand during the week-long holiday. This year's Lunar New Year holiday will see the market closed for one week starting on Jan. 31.
Chinese companies often sell yuan for dollars in the foreign exchange derivative markets to meet potential dollar demand during the holiday, and traders expect a shortfall of yuan this year because of the PBOC's tight liquidity stance in place since mid-2013.
But the central bank has recently pumped more liquidity to alleviate market demands for cash.
It injected 120 billion yuan ($19.83 billion) into the money markets through 21-day reverse bond repurchase agreements on Thursday, pumping a net 375 billion yuan into the markets this week.