The yuan stabilised against the dollar on Tuesday after the People's Bank of China (PBOC) set a slightly stronger midpoint for the currency, forcing investors to reassess views on how much Beijing will allow the yuan to weaken.
Despite yesterday's stronger fixing, the PBOC has set the mid-point weaker in the five of the past seven trading sessions, letting the yuan fall by a total of 0.44 per cent.
China recorded its biggest monthly trade deficit in a decade in February as exports continued to sputter, a development which market watchers believe has temporarily given the government an excuse to let the yuan weaken.
China's huge and persistent trade surpluses with the United States and many other countries are the main reasons why politicians in the West have pressured Beijing to let the yuan rise at a faster pace. The PBOC uses February's trade deficit as a good time to change its currency management tactics to some extent," said a dealer at a major European bank in Shanghai.
"It is expected to continue to manage the yuan's value in line with capital flows into and from China, including trade, foreign investment and speculative money."
Spot yuan was trading at 6.3236 against the dollar at midday, rebounding slightly from Monday's close of 6.3265.
Before trading began, the PBOC set the yuan's midpoint at 6.3259, slightly stronger than Monday's 6.3282.
That came after the central bank fixed the midpoint sharply lower on Monday, in what was its second biggest single-day fall on record.
The midpoint is the daily base rate from which the yuan could rise or fall 0.5 per cent in a day, used by the PBOC to help express the government intentions for the yuan's value.
The central bank has allowed the yuan to fluctuate more since Monday last week, when PBOC governor Zhou Xiaochuan said conditions were ripe for the exchange rate to float in a wider range.
Traders and analysts said the PBOC appears to be preparing domestic and global markets for sharper fluctuations to eventually widen the yuan's daily trading band.
But they said the greater volatility will not automatically lead the yuan to depreciate against the US dollar. The yuan is still expected to appreciate this year, although the pace in the first half may slow due to China's weakening export growth.
The currency is expected to rise 0.7 per cent in the first half, less than half of the 1.9 per cent pace seen in the same period last year, traders said.
While the central bank is likely to allow the yuan to stage more swings in coming months, traders expected the currency to move mainly in a range of 6.25 to 6.35 per dollar, and end the first half at around 6.25.
Many traders believe the government sets undisclosed targets for the yuan's exchange rate to help it manage the economy.
Boost to trading
"Sharper fluctuations may help activate trading," said a dealer at a Chinese commercial bank in Shenzhen.
"But the government's target range for a certain period of time, as believed by the market, is unlikely to change."
In the offshore non-deliverable forwards (NDF) market, the benchmark one-year NDFs implied yuan appreciation of 0.13 per cent in afternoon trade, down from 0.19 per cent appreciation implied at Monday's close.