Yuan Strengthens Most Since 2005 After China Signals End to Peg

The yuan rose the most since a July 2005 revaluation and forwards jumped after China’s central bank ended a two-year peg before a Group of 20 summit this week.

The currency advanced 0.42 percent to 6.7976 per dollar as of 5:30 p.m. in Hong Kong, the biggest gain since July 2005, according to data compiled by Bloomberg. The 12-month non- deliverable yuan forward rose 1.1 percent to 6.6425, implying traders are betting on a 2.3 percent appreciation.

A stronger yuan will help curb inflation in the world’s third-largest economy and shift investment toward service industries from export-manufacturing, the People’s Bank of China said yesterday. The move may also deflect criticism from President Barack Obama and other G-20 leaders, who say China relies on an undervalued currency to promote overseas sales.

“It will be a very gradual appreciation but it could be front-loaded,” said Nizam Idris, a Singapore-based currency strategist at UBS AG, the world’s second-largest foreign- exchange trader. “The yuan will appreciate about 4 percent this year and 5 percent next year.”

Asian currencies gained, with South Korea’s won strengthening 2.6 percent to 1,171.95 versus the greenback and the Taiwan dollar climbing 0.6 percent to NT$31.999. The MSCI Asia Pacific Index of regional stocks jumped 2.4 percent and oil rose 1.7 percent on speculation a stronger yuan will boost the purchasing power of the world’s most-populous nation. China’s government bonds gained and stocks rose.

The yuan’s spot rate touched 6.7958 earlier today, the strongest level since the central bank scrapped a peg against the dollar on July 21, 2005 and strengthened the currency by 2.1 percent in a single day.

Limited Gains

The move signals that “the recovery in the Chinese economy is on a more solid footing,” Philippine central bank Governor Amando Tetangco said in an interview yesterday. “This bodes well for intra-Asian trade and consequently growth for our economies. This could also encourage capital to flow into the region.”

Chinese authorities had prevented the currency from strengthening against the dollar since July 2008 to help exporters cope with the global financial crisis. The currency appreciated 21 percent in the three years after a managed float against a basket of currencies was introduced in 2005.

Gains this time around may be more moderate because the yuan has already strengthened 16 percent against the euro this year, eroding earnings for Chinese exporters in the European Union, the nation’s largest market. The yuan may climb 1.5 percent against the dollar to 6.7 by Dec. 31, according to the median estimate of 14 analysts surveyed yesterday by Bloomberg.

Testing the Bank

“Investors are buying and testing the central bank’s bottom line,” said Liu Dongliang, a Shenzhen-based analyst at China Merchants Bank Co., the country’s fifth-largest lender by market value. “But the central bank may take action when volatility is excessive.”

The People’s Bank set its daily yuan reference rate unchanged at 6.8275. The currency is allowed to fluctuate up to 0.5 percent from the official rate.

The central bank, which has accumulated $2.4 trillion in reserves by intervening in currency markets, said over the weekend it will allow greater currency “flexibility,” while maintaining the trading band, curbing inflows of short-term speculative capital and preventing “excessive” fluctuations.

Intervention Risk

“We can’t exclude the possibility of yuan depreciation,” said Shen Jianguang, Mizuho Securities Asia Ltd.’s chief economist for Greater China, who said a 2.5 percent drop is possible this year if the dollar-euro rate is unchanged. Even so, he added, China needs to show flexibility in its currency before the G-20 summit in Toronto on June 26-27.

U.S. Senator Charles Schumer said lawmakers will push ahead with proposals for trade sanctions until they are convinced the advance is fast enough to allow fair competition.

Textiles makers stand to lose the most from appreciation and some would “face bankruptcy” with profit margins as low as 3 percent, Zhang Wei, vice chairman of the China Council for the Promotion of International Trade, said in March. Europe’s debt crisis has added to pressure on their earnings. Swift Umbrella Co., based in the southern Chinese province of Fujian, was forced by European buyers to cut prices 6 percent this year, Xu Youchuan, sales manager, said in a June 2 interview.

Shrinking Surplus

China’s balance of payments indicates no need for “large changes” in the yuan, which is “not too far from equilibrium level,” the central bank’s statement said. The current-account surplus, the widest measure of trade, narrowed 32 percent to $297 billion in 2009, government data show.

Exports have been rebounding, exceeding imports by $19.5 billion in May, from a $1.68 billion surplus in April and a deficit of $7.24 billion in March. Overseas sales jumped 48.5 percent in May from a year earlier, customs bureau data show.

The World Bank said last week that a stronger currency would help China cool inflation, which accelerated to a 19-month high of 3.1 percent in May, higher than the government’s full- year target of 3 percent.

Bonds Rally

Bonds rallied with the yield on the 2.38 percent note due in May 2015 dropping five basis points to 2.8 percent. Relaxation of the yuan’s fixed exchange rate will spur capital inflows, helping ease a shortage of cash in the economy, Yang Hui, a fixed-income analyst at Citic Securities Co., China’s largest listed brokerage, wrote in a report today. It will also weaken expectations for an interest-rate increase, Yang wrote.

The Shanghai Composite Index, which tracks the bigger of China’s stock exchanges, gained 2.9 percent to 2,586.21. Companies focused on the Chinese market, including Beijing-based computer maker Lenovo Group Ltd. and Shanghai-based China Eastern Airlines Corp., said in March that they would gain from lower import costs and stronger consumer purchasing power.

The Chinese consumer “is feeling wealthier as a result of appreciation,” said Jing Ulrich, the chairperson for China equities at JPMorgan Chase & Co. “In the Chinese low-end manufacturing industries, what we will see is that the sector will move up gradually along the value chain.”

--Judy Chen, Belinda Cao, Bob Chen, Frances Yoon, Yanping Li, Patricia Lui. Editors: Sandy Hendry, James Regan

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

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