April 17 (Bloomberg) -- The yuan rose to the strongest since a link to the dollar was scrapped in 2005 after Premier Wen Jiabao reiterated the government's priorities are to prevent economic overheating and temper inflation.

The currency's 4.6 percent gain this year may narrow the record trade surplus by cutting costs of imported products and increasing prices of exports. China yesterday ordered domestic banks to set aside more cash for a third time in 2008 to reduce funds in the system that are keeping inflation near an 11-year high and helped spur first-quarter growth of 10.6 percent.

``As a major way to curb inflation, yuan appreciation will continue its fast pace in the second quarter,'' said Li Huiyong, an economist at Shenyin Wanguo Securities Research in Shanghai. ``The reserve ratio hike shows the government will focus its work on combating inflation.''

The yuan rose 0.11 percent to 6.9838 per dollar as of 5:30 p.m. in Shanghai, compared with a close of 6.9918 yesterday, according to the China Foreign Exchange Trade System. It touched 6.9834, the highest since a dollar link was abolished in July 2005.

``China will stick to a prudent fiscal policy and a tight monetary policy,'' Wen said in comments posted on the government's Web site yesterday following a State Council meeting.

Yuan Undervalued

Gross domestic product increased 10.6 percent in the first quarter, more than the 10.4 percent median estimate of 24 economists surveyed by Bloomberg News and after gaining 11.2 percent in the prior three months, a government report showed yesterday. Consumer prices rose 8.3 percent in March, little changed from February's 8.7 percent.

Lenders must place a record 16 percent of deposits with the central bank, the People's Bank of China said yesterday.

``We continue to expect further yuan gains in conjunction with monetary tightening amid rising inflation and a still strong macro economy,'' according to a report today from Claudio Piron and Yen Ping Ho, currency strategists with JPMorgan Chase & Co. in Singapore. The yuan's gains this year put the currency ``in a trajectory more than sufficient to reach'' its year-end target of 6.3, the report said.

The yuan has appreciated 18.5 percent versus the dollar since the end of a fixed exchange rate.

The currency is still 6 percent to 8 percent undervalued, Mark Mobius, who oversees $47 billion in emerging-market equities as executive chairman of Templeton Asset Management Ltd. said in a Bloomberg Television interview.

Bonds Little Changed

The People's Bank of China set the yuan reference rate at 6.9895 today. The currency is allowed to trade by up to 0.5 percent against the dollar either side of that rate.

``The stronger-than-6.99 reference rate prompted market forces to push the yuan up today,'' said Zhou Yajun, a foreign- exchange trader in Beijing at China Minsheng Banking Corp.

The yuan had been stuck in a range of about 6.99 to 7 for a week since it broke through 7 to the dollar on April 10 for the first time. Zhou forecast the yuan may end this week at the level of 6.98.

Government bonds were little changed following yesterday's data and the central bank's reserve ratio increase.

``The economic data came out as expected and the central bank's increase in reserves was less than we expected,'' said Wang Xiaoha, a bond trader with China Merchants Securities Co. in Beijing. ``It will take a while for the market to reach an agreement on whether another interest-rate hike is necessary.''

The yield on the treasury notes due in April 2010 was little changed at 2.8 percent, according to the China Interbank Bond Market. The price of the 2.77 percent security was 99.94 per 100 yuan face amount.

To contact the reporters on this story: Judy Chen in Beijing at xchen45@bloomberg.net; Belinda Cao in Beijing at lcao4@bloomberg.net

Last Updated: April 17, 2008 06:35 EDT