Yuan's Advance May Slow in Fourth Quarter, Bank of China Says

By Judy Chen

July 10 (Bloomberg) -- The yuan's gains will slow in the fourth quarter as authorities rely more on interest rates and less on currency appreciation to cool inflation, according to Bank of China Ltd., the nation's largest foreign-exchange trader.

The central bank will shift its policy later this year because a stronger currency will risk hurting exports, Shi Lei, a foreign-exchange analyst at Bank of China, wrote in a report dated yesterday. The yuan has strengthened 6.5 percent versus the dollar this year, almost matching the advance in all of 2007, as China seeks to lower import costs and stem inflation stoked by record oil prices.

``The yuan's appreciation can only curb a 20 percent gain in oil prices,'' Beijing-based Shi said. ``The side effects are a sharp drop in exports and a steep rise in imports, crippling China's manufacturers.''

The currency may rise 2 percent to 6.72 per dollar by the end of this quarter, and a further 1 percent in the fourth quarter to end the year at 6.65, Shi forecast. The currency closed at 6.857 in Shanghai yesterday, according to data compiled by Bloomberg.

Premier Wen Jiabao and Vice Premier Wang Qishan last week visited exporters in Jiangsu, Shanghai and Shandong, listening to their concerns about a decline in global demand, the state- run Xinhua news agency reported on July 5 and 6.

Exports may have risen 22.4 percent in June from a year earlier after gaining 28.1 percent in May, according to the median estimate of economists surveyed by Bloomberg News before the government reports the data by July 15. Imports increased 37.1 percent, according to a separate Bloomberg survey, as a stronger yuan boosted the spending power of Chinese consumers and companies.

`Rate Hike'

``The central bank will turn to rate hikes in the fourth quarter as inflationary pressure increases,'' Shi said in an interview yesterday, confirming the contents of the report. ``A rate hike may hurt exporters less than the yuan's rise.''

Non-deliverable forward contracts show traders have pared bets on the extent of the yuan's appreciation in the next 12 months. The currency will rise 5.7 percent to an implied rate of 6.49 a dollar in the next year, versus a prediction of 6.2755 on April 7, Bloomberg data show.

China has refrained from raising interest rates this year following six increases in 2007. It allowed the yuan to strengthen to curb the price of imports, and also ordered banks to set aside more deposits as reserves five times this year. Inflation quickened to 8.1 percent in the first five months, exceeding the government's target of 4.8 percent for this year.

The yuan was the best performer against the dollar in the past three months of the 10 most-active Asian currencies excluding the yen.

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net.