The yuan ended at a fresh record high on Friday as the central bank continued to allow the currency to rise to help fight imported inflation, but onshore traders remained convinced it would not resort to any one-off revaluation despite rumors overseas.
The People's Bank of China (PBOC) has set repeated record highs for the yuan's daily mid-point over the last several weeks, engineering an accelerated rise against the dollar that means it has now gained nearly 5 percent since it was depegged last June.
Those recent gains, together with comments this week by PBOC adviser Xia Bin that he would not rule out another one-off revaluation, have sparked talk among forex traders, especially those offshore, that such a move could be imminent.
But a number of reasons argue against such a possibility.
Policymakers as senior as Premier Wen Jiabao have repeatedly ruled out the possibility of another one-off revaluation, meaning any surprise would put the government's credibility at risk and could spark a backlash from the politically strong export sector.
Traders also point to the fact that the PBOC could allow a spurt in the yuan of 2 to 3 percent over the course of a few trading days if it wanted to, just by continuing to set its mid-point higher and allowing the currency to rise in daily trade, negating the need for any one-off move.
There would be huge pressure for the government to explain if it conducted another one-off yuan revaluation of 2 or 3 percent -- a goal it can now easily reach via the market, said a senior trader at a major Chinese state-owned bank in Beijing.
An even larger one-off yuan rise would surely create a huge political storm in a country where quite a large number of people still believe yuan appreciation is part of a Western conspiracy aimed to contain China's development.
CONTAINING FALL VERSUS BASKET
Still, what has become clear is that Beijing is increasingly ready to let the yuan strengthen against the dollar as a way to help contain the rising cost of imports, which was one reason why the country racked up a rare trade deficit in the first quarter.
While the official view in Beijing is that the yuan is no longer vastly undervalued, PBOC governor Zhou Xiaochuan pointed to the need to rely on the yuan in the inflation fight a week ago, echoing earlier comments by Premier Wen.
The need to move further on appreciation comes in part because the dollar has recently fallen to three-year lows.
Even though the yuan has risen by over 1 percent against the dollar so far this year, it has been falling against the currencies of other major trading partners given the dollar's weakness, making imports from places such as Europe more expensive.
So in a sense, the PBOC is just limiting the yuan's fall against other currencies, not engineering a rise outright, something traders said showed the government's continuing caution about disrupting exporters and other rate-sensitive sectors.
Spot yuan closed at a record high 6.5067 versus the dollar, up from Thursday's close of 6.5205. It has now risen 4.91 percent since it was depegged in June 2010, and 1.27 percent so far this year.
The PBOC has set a series of record high mid-points -- the level from which the dollar/yuan exchange rate can trade up or down 0.5 percent on a given day -- to express the government's intentions for the yuan to rise.
Judging by official comments, one might not expect a rise such as that over the last few weeks to continue for long.
Guan Tao, an official with the State Administration of Foreign Exchange (SAFE), said in remarks published in China Finance that the yuan should not be allowed to rise sharply, even while Beijing takes steps to rein in the growth in the country's foreign exchange reserves.
Still, traders said it may be more to China's benefit to let the yuan appreciate faster to take advantage of the higher value of the currency to fight inflation, while the PBOC could still pull back the currency quickly if market conditions change.
If the yuan rises too slowly, lagging conditions in the global market, China's economy may not be cushioned in time from the effects of imported inflation, traders said, noting that it was possible that policy makers had reached a common understanding on the necessity for quicker appreciation.
Revaluation or no revaluation, offshore traders continued to price in heightened expectations of accelerated appreciation over the next several months.
One-year dollar/yuan non-deliverable forwards (NDFs) were bid at 6.3220 in late trade, down from 6.3400 at Thursday's close.
Those levels imply the yuan will appreciate 3.06 percent in a year's time, compared with 2.76 percent implied a day earlier, leaving open a window to bet on more yuan strength in the NDFs.
NDFs appeared to be playing catch-up with widespread expectations of 5 to 6 percent yuan appreciation for 2011 after they lagged in forecasting the rise so far this year, partly due to capital outflows from the NDF market into Hong Kong's expanding yuan market.
(Additional reporting by Kevin Yao in BEIJING; Editing by Kim Coghill)