SHANGHAI, June 22 (Reuters) - The Chinese yuan slipped on Tuesday as big state-owned banks heavily bought dollars, a move that suggests the central bank has adopted a new strategy to control the pace of yuan gains.
The yuan jumped initially after the People's Bank of China set the mid-point start to trade at a surprisingly strong 6.7980 CNY=SAEC, little changed from Monday's close and catching market players off guard who had thought it would try to nudge the currency lower after the previous day's surge.
The heavy dollar buying quickly drove the yuan well off a low of 6.7900 -- the lowest since the 2005 revaluation -- and up as high as 6.8229 on the day, a drop of 0.37 percent. The yuan last traded at 6.8189 CNY=CFXS.
On Monday, the currency posted its biggest one-day rise since the revaluation, rising nearly half a percent and almost touching the upper it of its daily trading band on either side of the mid-point.
Some traders believe the buying by state-owned banks was on behalf of the PBOC to avoid direct market intervention, as it had often done in the post-revaluation appreciation phase and de facto dollar peg of the past two years.
By letting state-owned banks buy dollars, the PBOC is effectively limiting the market's ability to short dollar/yuan -- especially because banks are not allowed to hold short positions overnight in the spot currency market.
It appears a new strategy, said a senior dealer at a European bank in Shanghai. The central bank needn't intervene in the market, but it can still keep the pace of yuan appreciation under control via a control of supply and demand.
Because the state-owned banks were scooping up dollars at a wide variety of levels, it suggested that they were not trying to defend the yuan at a certain level, traders said.
But since the peg to the dollar was ditched over the weekend, the PBOC appears to be trying to foster much more two-way trade within the daily trading band, seeking to get banks and companies used greater volatility and hedging currency risks.
During the 2005-2008 managed float against a trade-weighted currency basket and subsequent peg to the dollar, the PBOC often squashed intraday volatility via direct intervention, guidance through the mid-point and dollar purchases by state-owned banks.
Now it appears to be backing away from direct intervention unless the extremes of the daily trading band are tested.
The PBOC has made clear that it would not allow the yuan to appreciate sharply in its statements over the weekend announcing the latest reforms of the yuan, ruling out a one-off revaluation.
Despite the announced intention of controlling the pace of yuan appreciation against the dollar, the PBOC showed it was backing its words with deeds by allowing the yuan to rise against European currencies on Tuesday.
The PBOC set the yuan's mid-point higher against the euro EURCNY=SAEC, at 8.3816, and against sterling GBPCNY=SAEC after the currencies weakened overnight. That set the tone for the yuan to trade higher against the euro EURCNY=CFXS at 8.3764 at midday on Tuesday from a close of 8.4325 the previous day.
The yuan can rise up to 3 percent against currencies besides the dollar.
The question is how far the yuan can go, said a senior dealer at a North American bank in Shanghai. We believe the central bank must have some limits, which may gradually become clear over time after the G20 summit.
Offshore dollar/yuan forwards rose back up after initial falls that had implied more yuan appreciation, buoyed by the dollar/yuan mid-point setting.
Some players in the NDF market have turned cautious about shorting dollar/yuan, worried that this week's yuan move was done primarily to appease critics before the G20 summit late this week, and later moves may be more subdued.
Three-month dollar-yuan non-deliverable forwards (NDFs) CNY3MNDFOR= were quoted at 6.7380, implying a yuan rise of 0.89 percent after they fell to a low of 6.7080 in early trade.
One-year NDFs CNY1YNDFOR= rose back to 6.6300 after hitting an initial low of 6.5970, trimming implied appreciation to 2.53 percent from 3.05 percent the previous day. (Editing by Eric Burroughs & Jan Dahinten)