SHANGHAI, June 23 (Reuters) - The yuan CNY=CFXS closed slightly higher on Wednesday after the central bank nudged the mid-point higher, but dollar buying by state-controlled banks suggested that officials were trying to keep currency gains in check.
The dollar purchases by big local banks were smaller than the hefty buying on Tuesday, but the actions by the banks have made it difficult for market players to sell the U.S. currency for yuan by absorbing so much dollar supply.
Traders said it appeared People's Bank of China was operating through the state-controlled banks to limit the yuan's rise, even while shying away from the direct intervention often used in the past to reduce intraday volatility.
That suggested the PBOC still had a very heavy hand in controlling trade even as it has allowed more two-way activity within the 0.5 percent daily trading band since ditching the de facto U.S. dollar peg over the weekend.
Yuan trading settled down after two hectic days that saw the currency jump to a post-revaluation high of 6.7900 versus the dollar but then pull back sharply. Graphic on volatility: r.reuters.com/gyx53m
The yuan closed at 6.8124 to the dollar CNY=CFXS, slightly weaker than the day's mid-point of 6.8102 but up 0.02 percent from Tuesday's close of 6.8136.
For the week, the yuan has risen a mere 0.20 percent.
The PBOC has once again proved that it has control over the pace of yuan movements. No one wants to fight with the central bank, so trading is becoming a sort of guessing game about how the PBOC will let the yuan move, said a senior trader at a big Chinese bank in Shanghai.
A new framework is taking shape for the PBOC to control the yuan after it made clear over the weekend that it would not allow sharp appreciation and ruled out a one-off revaluation.
Some big Chinese banks are buying dollars in such large amounts that they could not be acting on demand from clients or for proprietary trading, traders said, leading to the conclusion that they are buying on the PBOC's behalf.
These banks also appear to be concentrating a large volume of their deals in the final minutes of trading, with their final dollar/yuan quotes helping the central bank to set the tone for the following day's mid-point, the reference rate from which the yuan can move up or down 0.5 percent.
Some weak quotes emerged for the yuan in the final 10 minutes of trading on Wednesday, pushing it to an intraday low of 6.8208, which could signal that Thursday's yuan mid-point will be set slightly weaker than Wednesday's, dealers said.
By effectively taking control of dollar supply and making closing prices an important barometer for the yuan's movements, the central bank is able to have its intentions clearly felt by the market, said a North American dealer in Shanghai.
The yuan's mid-point CNY=SAEC on Wednesday partly reflected a mild rally in the dollar index .DXY overnight, traders said.
But the yuan mid-point was down from Tuesday's, which was the highest since the yuan's revaluation in July 2005, as the central bank had paved the way for a weakening of its reference rate via state banks' purchases of dollars on the spot market.
Dealers said it would no longer be very difficult for the market to guess the next day's mid-point, or more precisely, the central bank's intention on yuan movements.
But dealers added that the mid-point could also be wielded on occasion as a ready weapon for the PBOC to control the yuan's rises and falls during times of global market volatility and emergencies. The PBOC consults with banks but keeps the market in the dark as to how it sets the actual rate.
Despite the cental bank's tight grip on the yuan, dealers said state banks are now buying dollars at a much wider variety of levels, a clear indication that the PBOC is creating a more volatile exchange market.
The yuan moved in a 138-pip range between 6.8070 and 6.8208 on Wednesday, which was down from 329 pips on Tuesday and 314 pips on Monday -- but still relatively wide given the market's narrow movements of the past two years.
The PBOC had largely confined the yuan's daily fluctuations to just a few pips during the global financial crisis.
It could be considered engineered volatility but it nevertheless is a step towards a more market-oriented yuan exchange rate, said a dealer at a European bank in Shanghai.
Speculation about yuan appreciation eased in the offshore market as well, with players becoming cautious about shorting dollars, worried that Beijing's move was engineered primarily to appease critics before the G20 summit late this week.
Benchmark one-year NDFs CNY1YNDFOR= rose to 6.6660 from Tuesday's close of 6.6500, pushing implied 12-month yuan appreciation down to 2.16 percent from 2.23 percent the previous day, as measured from the central bank's spot mid-point. (Editing by Eric Burroughs and Edmund Klamann)