July 10 (Bloomberg) -- The yuan advanced to the highest since China ended a dollar link in 2005 on signs that policy makers will strengthen the currency to curb inflation. Bonds rose.

Premier Wen Jiabao said this month that the battle against inflation will be his government's top priority. The yuan has appreciated 2.2 percent versus the dollar in the past three months, the best performer among the 10 most-active currencies in Asia excluding the yen, as inflation accelerated to 8.1 percent in the first five months.

``The central bank still needs a stronger currency to ease the upward pressure on consumer prices,'' said Li Wei, an economist at Standard Chartered Plc in Shanghai. ``But bigger fluctuations in the exchange rate will replace one-way appreciation.''

The yuan climbed 0.21 percent to 6.8428 per dollar in Shanghai as of the 5:30 p.m. close of trade from 6.8570 yesterday, according to the China Foreign Exchange Trade System. It touched 6.8420 today, the strongest since the dollar peg was abandoned. Li forecast the currency will rise to 6.55 by the end of this year.

The People's Bank of China fixed the reference rate for yuan trading at 6.8489 against the dollar today, the highest since the end of the fixed exchange rate.

Import Costs

The strengthening of the yuan has helped lower import costs as oil prices reached a record $145.85 a barrel on July 3. The yuan is allowed to trade by up to 0.5 percent against the dollar either side of the so-called central parity rate.

Overseas shipments grew 17.6 percent in June from a year earlier, after gaining 28.1 percent in May, the customs bureau said on its Web site today. That was less than the 22 percent median estimate of 23 economists surveyed by Bloomberg News.

The trade surplus narrowed 20.6 percent to $21.4 billion from a year earlier, according to the government, the third straight reduction.

``Faster currency gains hurt exporters already squeezed by raw-material and labor costs and taxes,'' said Sun Mingchun, an economist at Lehman Brothers Holdings Inc. in Hong Kong.

Government bonds rose for a second day before a government report next week that will probably show the economy grew at 10.2 percent in the second quarter, slowing from 10.6 percent expansion in the first three months of the year, according to the median estimate of economists surveyed by Bloomberg News.

The yield on the 4.01 percent note due in May 2015 fell 3 basis points to 4.27 percent, according to the China Interbank Bond Market. The price climbed to 98.47 from 98.30. A basis point is 0.01 percentage point.

``Demand for bonds is increasing,'' said Qu Qing, a fixed- income analyst at Shenyin Wanguo Research and Consulting Co. in Shanghai. ``Slowing growth means there is little room for the central bank to raise interest rates.''

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net; Jiang Jianguo in Shanghai at jjiang@bloomberg.net.

Last Updated: July 10, 2008 05:53 EDT