Yuan Set for Biggest Gain Since May, Helping Address Trade Gap

By Judy Chen and Belinda Cao

Aug. 22 (Bloomberg) -- China's yuan was headed for the biggest weekly gain in three months on speculation officials will seek a stronger currency to curb the trade surplus and deter the U.S. from imposing penalties. Bonds rose.

China needs ``more flexibility'' in the exchange rate to manage its economy amid a global slowdown, John Lipsky, the International Monetary Fund's first deputy managing director, said yesterday in Jackson Hole, Wyoming. This week's advance ends a run of four straight losses and extends the currency's gain this year to 7 percent, more than it rose for all of 2007.

``The yuan will probably regain appreciation after the Olympics,'' said Li Huiyong, an economist at Shenyin Wanguo Research & Consulting Co., part of China's third-largest brokerage firm, in Shanghai. ``The huge trade surplus is the biggest reason for the medium and long-term appreciation.''

The yuan rose 0.6 percent this week to 6.8296 a dollar as of 3 p.m. in Shanghai, from 6.8700 late last week, according to the China Foreign Exchange Trade System. That's the biggest weekly advance since May 23. It climbed 0.21 percent today, the largest one-day gain since July 29.

China's central bank has managed the yuan's exchange rate against a basket of currencies, including the yen and the euro, since a peg to the dollar was scrapped in 2005. Both currencies rallied more than 1 percent against the dollar yesterday.

Stronger Rate

The People's Bank of China set a stronger reference rate for yuan trading for a fourth straight day. The yuan is allowed to trade by up to 0.5 percent against the dollar either side of the daily rate, which was fixed at 6.8357 today.

China's trade surplus expanded 4 percent from a year earlier to $25.3 billion in July, the first increase in four months, according to customs bureau figures released last week. U.S. Treasury Secretary Henry Paulson said this week that U.S. proposals to punish China for depressing the value of the currency might spark an unproductive ``trade war.''

The local currency touched a two-month low of 6.8808 a dollar on Aug. 18 on speculation policy makers would prefer to bolster growth rather than fight inflation on signs a global slowdown crimped demand for the nation's exports. The yuan has declined about 0.1 percent in the past month.

China's economy expanded 10.1 percent in the second quarter from a year earlier, the slowest pace since 2005. Export growth cooled to 17.2 percent in June from a 28.1 percent gain in May, government data show. It accelerated to a 26.9 percent pace last month.

Growth Scare

``A post-Olympics growth scare in China is now more probable than we had thought six months ago,'' Stephen Jen, London-based head of research at Morgan Stanley, wrote in a research report yesterday. ``Such a regional growth scare will provide further support to our call'' for Asian currencies to weaken versus the dollar.

Traders in the forward market have pared bets on how far the yuan will advance. Forward contracts show the yuan will rise 3.2 percent to 6.6175 in a year, compared with around 11 percent appreciation predicted earlier this year.

Standard Bank in London recommended buying the Chinese currency, playing down chances policy makers will shift focus to supporting the economy and citing global calls for appreciation.

``We are skeptical that they will see slower appreciation, or even depreciation, as a way to stimulate growth,'' Steve Barrow, a currency strategist with Standard Bank in London, wrote in a report yesterday. ``The renminbi is a buy.''

Corrected Too Far

Even as the dollar strengthens against major currencies, like the euro, the U.S. Treasury will ``want to keep pressure on China for renminbi appreciation,'' Barrow said. ``It seems so clear to us it has corrected too far in the other direction.''

The Chinese currency has gained 6.5 percent versus the euro and 4 percent against the yen this quarter, compared with a 0.3 percent appreciation versus the dollar.

Barrow said the yuan's annual appreciation of 5 to 10 percent is ``much more appropriate.'' The U.S. is the biggest buyer of China's exports and its trade deficit with the Asian nation ballooned to a record $256 billion last year.

Government bonds gained for a second week after China said inflation slowed in July, spurring speculation consumer prices will continue to fall and the central bank won't raise interest rates later this year.

Consumer price increases slowed to 6.3 percent in July, from 7.1 percent a month earlier, the statistics bureau said Aug. 12. The yield on benchmark 10-year bonds dropped 4.4 basis points this week, according to data compiled by the country's biggest debt clearing house. A basis point is 0.01 percentage point.

``The inflation rate may continue to fall later this year,'' said Dong Dezhi, a bond analyst with Bank of China Trading Center in Shanghai. ``Market sentiment is still optimistic.''

The yield on the 4.41 percent bond due June 2018 dropped 1 basis points to 4.35 percent in Shanghai as of 3:22 p.m., according to the China Interbank Bond Market. The price of the security rose 0.08 per 100 yuan face amount to 100.47.

To contact the reporters on this story: Judy Chen in Shanghai at xchen45@bloomberg.net; Kim Kyoungwha in Beijing at kkim19@bloomberg.net.