6 Min Read
* C.bank sharply strengthens yuan's midpoint rate
* Traders say big state-owned banks sold dollars to support yuan
* C.bank has 'let the yuan bulls loose' - analyst
* Offshore yuan gains 2 pct in last six sessions (Adds Hong Kong Monetary Authority comments in paras 13-15)
By Winni Zhou and John Ruwitch
SHANGHAI, June 1 (Reuters) - China's yuan surged to a near seven-month high on Thursday, reinforcing views that the central bank will no longer tolerate much depreciation against the dollar and is setting the currency on a firmer path.
Spot yuan strengthened through 6.8 per dollar for the first time since Nov.11 in early trade before retreating and settled at 6.8061 by the close of trade in China.
The 4:30 p.m. (0830 GMT) settlement price was still nearly 0.2 percent firmer than the previous late session close.
Early in the day, the central bank pushed the reference rate for the yuan up by 0.8 percent, the midpoint's second largest one-day appreciation since the currency was de-pegged from the dollar in 2005.
After months of holding the yuan relatively stable against the dollar, China has suddenly allowed the currency to advance about 1.2 percent since May 24, when Moody's Investors Service downgraded its sovereign credit rating for the first time since 1989.
Some traders believe the gains have been engineered as a show of strength by China to scare off short sellers after the downgrade, while others think the policy shift may have been in the works for some time to fix a flaw in the fixing mechanism which left the currency more susceptible to depreciation.
Authorities on Friday confirmed they are adding a "counter-cyclical" factor to their calculations of the daily reference point to curb persistent depreciation expectations. But they did not elaborate, and markets are puzzling over what the new "X" factor is, if it is quantifiable at all.
"The PBOC has let the yuan bulls loose in the China shop," said Stephen Innes, senior trader at OANDA in Australia, referring to the People's Bank of China.
"Needless to say, the market is a tad shell-shocked this morning while searching for some policy clarity from the PBOC."
Traders said major state-owned banks were selling dollars, which helped keep the yuan strong. Many market participants believe dollar selling by the biggest state-owned banks in recent weeks has been a key part of government efforts to support the exchange rate.
In the offshore market, the currency has strengthened by about 1.8 percent since the rating downgrade.
"The change (in the calculation method) gives the PBOC more leeway to ignore market moves when determining the fix – as such, it is a further sign of reluctance at senior levels to allow prices to be set by market forces," Capital Economics said in a note.
Earlier on Thursday, the CNH Hong Kong Interbank Offered Rate benchmark (CNH Hibor), the island's overnight yuan borrowing rate, jumped to 42.81500 percent, its highest in nearly five months.
The Hong Kong Monetary Authority (HKMA) responded in an emailed statement saying that the interbank market on the whole was operating in an orderly manner after noting the tightness in CNH liquidity and that it had provided liquidity support to banks.
"We will continue to closely monitor the CNH market," HKMA said.
Chinese stocks also have risen after Moody's move, and some analysts believe the hand of the state is behind moves designed to dissuade bears. Stocks had been in retreat in recent weeks as regulators cracked down on riskier types of financing and borrowing costs increased.
The yuan lost 6.5 percent of its value against the surging dollar in 2016 and analysts polled by Reuters have repeatedly predicted it would shed another 3-5 percent this year if the U.S. Federal Reserve continues to slowly raise interest rates, buoying the greenback's appeal.
But so far this year, it has gained about 2.3 percent, and the appreciation of recent days has forced some analysts and investors to reconsider their outlook.
"The sudden surge in the yuan caused some panic among bank clients. Unlike the previous rallies in the yuan, this time, the one-way expectation of yuan depreciation has changed," a Shanghai-based trader at a Chinese bank said.
"Some clients were considering liquidating their dollar positions to stop losses. The next key level might be around 6.78 per dollar level," the trader said.
Indeed, investors in the last two weeks have increased their long positions on the yuan to the largest in almost two years, a Reuters poll showed on Thursday.
Financial News, a newspaper owned by the PBOC, said in a front page commentary on Thursday that adopting measures to stabilise expectations for financial markets and boost confidence is a good idea at a time when investor confidence was "relatively fragile".
"And it is more important to let the market understand that the Chinese economy has showed good and stable momentum, which would provide a solid base for stabilising development in the future," the paper said.
Traders last week said major state-owned banks were selling dollars in the onshore market - a move sometimes interpreted as part of the government's efforts to prop up the yuan.
On Thursday, the yuan midpoint was fixed at 6.8090 per dollar, lifting it 543 pips from the previous day's rate to its strongest level since Nov. 10.
But the currency is forecast to weaken to 7.05 per dollar in 12 months, according to a poll of over 50 foreign exchange analysts taken this week, even as market confusion reigns over what China is up to.
Zhou Hao, an economist at Commerzbank in Singapore, said the administrative measures and market intervention could help stabilise the onshore and offshore yuan exchange rates, but there was "little fundamental support" for a stronger yuan.
"We still believe USD-CNY will spike up eventually," he said in a note. (Additional reporting by Yawen Chen in Beijing and Saikat Chatterjee in Hong Kong; Editing by Richard Borsuk and Kim Coghill)