China's central bank set its strongest midpoint in eight months on Tuesday after a fall in the dollar the day before, pushing the yuan close to its all-time high and raising the prospect of further appreciation.
The yuan changed hands at 6.2235 per dollar in early trade, a whisper away from late November's record high of 6.2223. The currency had retreated to 6.2258 near midday, 0.06 percent firmer than Monday's close.
The central bank's midpoint of 6.2804 on Tuesday was its strongest since May 2012, though still only 0.1 percent stronger than Monday's fix of 6.2872. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 1 percent from the midpoint it sets each morning.
The stronger central bank fixing came in response to an overnight fall in the dollar against the euro and other currencies, as investors anticipate a continuation of easy monetary policy from the Federal Reserve.
The PBOC typically fixes the yuan firmer when the dollar index falls overnight. But traders say Monday's unusually strong response to that fall may also signal the PBOC's willingness to permit some yuan appreciation following six weeks during which authorities have capped the currency's rise.
The yuan hit the top-end limit of its daily trading band nearly every day in November and early December, creating a deadlock during which trading volume evaporated as dollar bids were absent from the market.
Only when major state banks – apparently acting on behalf of the PBOC – stepped in to buy dollars in mid-December did liquidity return to the market.
Though the PBOC is no longer intervening on such a large scale, most traders believe that major state banks are still standing guard, buying dollars as necessary to keep the yuan clear of its top-end limit.
Though such theories are impossible to confirm, traders point to how the exchange rate has remained close to the band limit without touching it.
The central bank has stated repeatedly that it intends to reduce its intervention in the FX market.
Setting the midpoint stronger would relieve the PBOC and state banks of maintaining market liquidity while also keeping the exchange rate inside the band.
With signs that China's economic recovery is on firm footing while inflation may be on the rebound, the central bank may now be more comfortable allowing the currency to appreciate. But traders caution that a single day's