The yuan closed slightly higher versus the dollar on Friday after the midpoint rebounded from its biggest 11-session fall on record, in line with a drop in the dollar index on Thursday in global markets.
The People's Bank of China (PBOC) has signalled that yuan trade will correlate to the dollar but has also shown more willingness to let its daily midpoint fixing fluctuate in a wider range, traders said.
The yuan's fixing is seen likely to fluctuate more when the US dollar index stages sharp volatility.
As such, traders believe the yuan will find a floor at around 6.35/dollar in the near term unless the dollar index breaches 81.784, its highest level this year.
Longer term, they see the yuan continuing to appreciate but at a slower pace this year compared with 4.7 per cent appreciation in 2011.
A Reuters poll published on Friday showed China could double the yuan's daily trading range as soon as the second quarter and let the yuan rise 2.8 per cent from current levels by the end of this year.
"A new pattern of PBOC fixing of the midpoint appears to be emerging, and it appears to have limits for the yuan to not move too sharply, too fast," said a senior trader at a Chinese commercial bank in Shenzhen.
"In another indication of such limits, the yuan has still moved very little in trading in contrast to the midpoint, meaning the PBOC is not yet ready to let the market decide the yuan's value."
Spot yuan closed at 6.3227 against the dollar, up slightly from Thursday's close of 6.3300.
Before trading began on Friday, the PBOC set the yuan's midpoint at 6.3200, up 0.25 per cent from Thursday's 6.3359, in one of its rare hikes since China established the domestic foreign exchange market in 1994.
The PBOC's fixing had lost 0.7 per cent over 11 trading sessions until Friday in its biggest 11-session loss in the market's history as the central bank encouraged two-way trading.
The midpoint is the daily base rate from which dollar/yuan can rise or fall 0.5 per cent in a day, used by the PBOC to help express the government's intentions for the currency's value.
The PBOC appears to be testing market reaction for a weakening of the yuan since the start of March while officials state that the government needs to widen the range for yuan trading.
While the PBOC has talked about a widening of the yuan/dollar trading band for years, real two-way trade has been slow taking off. This time it appears to be encouraging the normally tightly managed yuan to trade over a wider range, traders said.
Still, traders said they believed China was in the early stages of allowing the yuan to trade more freely in line with market conditions and it may take the government at least a few months to decide on any yuan policy changes.
For now, the PBOC will keep a tight grip on the yuan's value, with its midpoint largely deciding the yuan's direction and the extent of a daily fall or rise, while the yuan has continued trading in a relatively narrow range.
Dealers said the market may well lose its direction if the PBOC loosens its grip immediately because Chinese companies have never been given the right to price the currency.