March 14 (Bloomberg) -- The yuan rose to the highest level since the end of a dollar link in 2005 as the dollar weakened and China sought to combat inflation at an 11-year high. Government bonds gained.

China's yuan climbed as the U.S. currency touched a record low against the euro on concern increasing credit- market losses will drag the world's biggest economy into a recession. China's annual inflation rate accelerated to 8.7 percent last month from 7.1 percent in January, the government said March 11.

``The recent fall in the dollar may have hurt people's confidence and driven them to convert dollars to renminbi,'' said Wen Li, a foreign-exchange trader at Bank of China Ltd. in Beijing. The yuan is a denomination of the renminbi.

The yuan was at 7.0894 per dollar as of 5:30 p.m. in Shanghai, compared with a close of 7.0900 yesterday, according to China Foreign Exchange Trade System. It touched 7.0844, the strongest since the dollar peg was scrapped in July 2005.

The People's Bank of China set the daily reference rate for its currency at 7.0882 per dollar today. The yuan is allowed to trade by up to 0.5 percent on either side of that.

``If the dollar continues to be weak, the yuan reference rate will keep rising at a slow pace until the National People's Congress ends its meeting on March 18,'' said Yang Shengkun, a foreign-exchange analyst at China Citic Bank Co. in Beijing.

The National People's Congress, China's parliament, began its annual meeting in Beijing on March 5 to formulate laws and appoint officials.

Rates Versus Yuan

A strengthening yuan helps China ease inflation by lowering import costs and reducing the inflow of money from the trade surplus as export prices rise. Premier Wen Jiabao said March 5 that the government aims to cap the inflation rate at 4.8 percent this year and is seeking to prevent a shift ``to overheating from relatively fast growth.''

``A stronger yuan is one of the limited tools the central bank can use to help reduce the trade surplus and also curb inflation,'' said Tang Liang, a foreign-exchange trader at the Beijing Branch of Industrial & Commercial Bank of China Ltd. ``The PBOC may find it even harder to raise rates than appreciate the yuan.''

Following the legislature's meeting, ``faster yuan appreciation will come, with a daily change of about 100 to 200 basis points,'' said Zhuang Zhiqiang, a foreign-exchange analyst at Xiamen International Bank Co. Ltd. ``It will touch, or at least get quite close to, 7.0 by the end of this month.''

The yuan will reach 6.70 per dollar by the end of 2008, according to the media estimate of 27 analysts surveyed by Bloomberg News. Forward contracts show the yuan will rise 11 percent to 6.3250 in the next 12 months.

Bonds Advance

Government bonds rose on speculation the central bank is unlikely to keep raising interest rates as the U.S. Federal Reserve cuts borrowing costs to bolster its economy.

``Banks, which are flush with funds to buy debt, are growing less concerned there will be an interest-rate increase now,'' said Nie Shuguang, a debt trader at the Shanghai Branch of the Industrial Bank Ltd. ``Concern over a widening interest-rate premium will prevent the PBOC from lifting rates.''

The Fed has cut its benchmark rate five times since September, pushing down the cost of borrowing in dollars for one year to less than the yield on similar-dated yuan bills sold by China's central bank.

China's benchmark interbank seven-day repo rate, which reflects borrowing costs among financial institutions, fell 5.2 basis points to 2.5 percent, according to the National Interbank Funding Center.

The yield on the 4.35 percent treasury note due November 2014 fell 1 basis point to 3.96 percent, according to the China Interbank Bond Market. The price rose 0.04 per 100 yuan face amount to 102.22. A basis point is 0.01 percentage point.

To contact the reporters on this story: Judy Chen in Shanghai at Xchen45@bloomberg.net; Belinda Cao in Beijing at lcao4@bloomberg.net.

Last Updated: March 14, 2008 06:06 EDT