SHANGHAI: China's yuan weakened to a four-month low against the dollar on Tuesday, with the US currency drawing support from prospects of a solid economic recovery thanks to accelerating vaccinations and massive fiscal stimulus.

The strong upward momentum for the dollar is keeping the yuan on course for its worst monthly performance since August 2019.

Prior to market opening, the People's Bank of China (PBOC) set the midpoint rate at a four-month low of 6.5641 per dollar, 225 pips or 0.34% weaker than the previous fix of 6.5416.

The much weakened official guidance was largely in line with market expectations and dragged the spot prices lower. The onshore yuan opened at 6.5790 per dollar and weakened to a low of 6.5799, the softest level since Dec. 1, 2020.

By midday, the spot yuan was changing hands at 6.5711, 21 pips weaker than the previous late session close.

Traders said the stronger greenback discouraged some corporate clients from converting their dollar receipts into the local currency.

A few other traders noted the safe-haven dollar gained some support from market worries over the potential fallout from the collapse of hedge fund Archegos Capital.

A trader at a foreign bank said the yuan could test the psychologically important 6.6 per dollar level.

"Momentum remains weak for CNY which we see depreciating to 6.68 by mid-year," analysts at DBS said in a note.

"Apart from a firmer USD globally, the CNY has been pricing out earlier optimism that US-China tensions would ease under the Biden administration."

Separately, index provider FTSE Russell gave final approval on Monday for inclusion of Chinese sovereign bonds in its flagship bond index, starting later this year, setting the stage for billions of dollars of inflows into the world's second-largest economy.

Foreign capital inflows were among one of the key factors supporting the yuan last year.

Goldman Sachs revised up its capital inflow projections for 2021 to $150-180 billion, from $120-140 billion previously.

"While China's lower estimated weight and much longer scale-in period should lead to flatter inflow projections, we note that year-to-date inflows have been much stronger than expected with January registering inflows of $33 billion and February of $13 billion," the investment bank said in a note.

The global dollar index rose to 92.92 at midday, while the offshore yuan was trading at 6.574 per dollar.