LONDON (Reuters) - The Bank of England is prepared in principle to become the first G7 central bank to enter into a foreign exchange swap agreement with China, opening the door to another substantial step in moves to liberalise the yuan currency.
The bank's Executive Director for Banking Services, Chris Salmon, told a meeting of senior bankers in London that the move was aimed at underpinning a developing offshore market in yuan trade out of London that Britain is keen to encourage.
It would be the latest in a string of bilateral currency agreements that China has signed in the past three years to promote use of the yuan in trade and investment.
British officials have previously shied away from such a deal because the renminbi (yuan) is not freely exchangeable. But there have been signs that China is moving to open up trading of its currency and Salmon said the bank was more interested in helping yuan business to flourish.
"The Bank would welcome the development of the offshore RMB market just as it would any other legitimate market innovation, and we would not want to inhibit that outcome inadvertently through gaps in our operational framework," he told the London Money Market Association's Executive Committee in the text of his speech provided by the bank.
"To remove any residual uncertainty about our attitude: the Bank is ready in principle to agree a swap line with the PBOC (People's Bank of China), assuming a mutually agreeable format can be identified."
European and U.S. officials have been pressing China for years to do more to open up the yuan to market forces, saying its artificial weakness was one of the key imbalances of the global economy.
Beijing is slowly delivering, although it still keeps a tight rein on gains for the currency for fear it will weaken an economy that has been the biggest engine of global growth for a decade.
"This is part of the internationalisation of the RMB, this is China moving forward to internationalise its currency," said David Bloom, head of FX strategy at HSBC.
"They are setting up these lines around the world, it is the beginning of the opening up of the flower of the RMB."
Britain, always anxious to bolster London's status as Europe's biggest financial centre, launched an offshore yuan currency and bond market to great fanfare last year and a swap deal would cement its role as the leading centre in the Group of Seven industrialised nations for offshore yuan trade.
But bankers have been arguing for some time that the bond side would struggle to develop unless British and Chinese authorities took steps to make trading easier.
The need for such measures has become even greater in recent months as potential investors have been discouraged from buying yuan bonds by China's slowing economic growth and a slump in one-year yuan non-deliverable forwards to price in a depreciation.
"Ultimately, the growth of the market will depend on the success of market participants in matching incipient demand and supply for RMB denominated products - just as the original eurodollar market grew by satisfying a latent private sector demand for dollar assets in this time zone," Salmon said.
"That said, there is a perception that market confidence would be boosted if the Bank and the PBOC agreed a swap line."
Issuance of London-listed yuan bonds has been limited to a handful from the likes of oil major BP and banks HSBC and ANZ.
By comparison, the Hong Kong yuan bond market grew to around 350 billion yuan (35.2 billion pounds) in a little over two years from 2010, according to Thomson Reuters data.
But industry players say foreign exchange trading out of London itself looks far better, with daily turnover levels having risen to up to $900 million, compared with $1.5 billion in Hong Kong.
Figures from global transaction services organisation SWIFT also show the UK is the leading centre for offshore yuan trade outside Asia and has made far more progress in getting companies to invoice in yuan than the United States, for example.
Reporting by Patrick Graham; editing by Ron Askew