China's central bank set the yuan's midpoint above 6.60 per dollar for the first time on Thursday, breaching an important barrier just days before Chinese President Hu Jintao travels to Washington.
The yuan's rise in the last few days, on the back of successive record highs in its daily midpoint, reflects a long-held pattern of Beijing allowing appreciation of the currency ahead of big political meetings, where it often faces calls for the yuan to strengthen further.
U.S. Treasury Secretary Timothy Geithner ratcheted up that pressure on Wednesday, saying China needed to let the yuan strengthen more quickly, while adding that quicker appreciation could open up access to U.S. "dual-use" technology that is currently restricted for export.
While analysts were somewhat skeptical over what might be achieved on the currency issue during the Jan. 19 summit between Hu and U.S. President Barack Obama, the yuan's move beyond 6.6 per dollar is significant.
"The breach of the 6.6 level may not be as exciting an event as many market players believe, but its significance must not be underestimated: The central bank has allowed a new round of yuan appreciation," said Liu Dongliang, senior currency strategist at China Merchants Bank in Shenzhen.
"Recently, the central bank has stated its intention of strengthening its anti-inflation fight, giving the market confidence that overall yuan appreciation will be quickened in 2011."
ON CHINA'S OWN TERMS
The People's Bank of China (PBOC) set the tone for a strong day for the currency by setting the mid-point for daily trading against the dollar at 6.5997.
That marked the first time it had been set stronger than 6.60. The rate set by the central bank is the point from which the renminbi can rise or fall 0.5 percent on a given day.
In spot trading, the yuan rose to around 6.5970 versus the dollar by mid-afternoon, a rise of 3.5 percent since last June when authorities dropped a peg with the U.S. dollar that had been set to support the economy during the global financial crisis.
U.S. businesses and officials want China to allow the currency to rise at a faster pace to help narrow a trade gap, which Chinese data this week showed had widened in 2010 by 26 percent to $181 billion.
Geithner reiterated on Wednesday the need for a faster appreciation of the yuan and added that such a move could lead to an easing of restrictions on U.S. exports of technology with both civilian and military use to China.
The comments opened up a new angle on discussions over the yuan as Hu and Obama prepare to meet next week in what is being billed as the most important state visit in 30 years.
But it could be too little too late, and could be viewed in Beijing as Washington offering something it would eventually have to concede anyway, some Chinese analysts said.
"China has never thought of the yuan appreciation from such a perspective," said Ding Yifan, deputy head of the World Institute at the Development Research Centre, a think-tank under the State Council, China's cabinet.
"The United States has always known that China has to let the yuan rise. They want to take advantage of this. The Chinese yuan will not rise in a way designed by the United States."
China-based currency traders said they expected the yuan to continue to gain in the next week or two as Beijing looks to lay a positive foundation for Hu's talks with Obama, but that its rise could slow again afterwards.
"It will be a very familiar format, that the yuan jumps during a major political event and then pulls back," said a senior trader at a North American bank in Shanghai.
Onshore traders said the yuan had the potential to rise around 500 pips by the end of Hu's U.S. visit on Jan. 21, with a ceiling seen at 6.55 and a floor at 6.60 in the weeks after the visit.
Offshore dollar/yuan forwards initially fell across most of the curve to imply more yuan appreciation after Thursday's strong mid-point.
The three-month dollar/yuan forward hit a record low, but then rebounded, supporting the view that the spurt in the yuan could lose momentum.
While the yuan's gains against the dollar have accelerated since the peg was dropped and especially during the last month, its value against a trade-weighted basket has stayed largely stable.
By the end of the year though, China is seen allowing the yuan to rise 5.4 percent to around 6.3 per dollar as part of its efforts to quell inflation, a Reuters poll of more than 40 economists and strategists showed this week.
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