China central bank seen ready to intervene again if offshore pushes yuan too far

HONG KONG - A spike higher in the offshore yuan following suspected rare intervention by Chinese state banks is expected to be short-lived, especially with a looming US interest rate rise likely to add to the attraction of owning dollars.

But those betting on a further depreciation in the yuan are likely to have only limited room to push the offshore rate down relative to the onshore rate without drawing the ire of the Chinese central bank and the risk of further state intervention, market sources said.

"The central bank will not stand aside if depreciation expectation is formed again and more intervention may happen,"said a Hong Kong-based currency trader, who declined to be identified.

The offshore yuan shot up by more than 1 per cent on Thursday on suspected intervention that was seen by traders as a gesture by authorities to shake out speculators betting against the yuan.

Authorities have spent the country's foreign exchange reserves heavily to hold the yuan steady onshore since a surprise devaluation in August prompted fears the Chinese economy was in worse shape than previously thought and that the yuan therefore could fall further.

Thursday's spike narrowed the offshore yuan's discount against the onshore rate to 0.38 per cent from 1.56 per cent on Wednesday and forced traders with short positions to cover.

Traders suspect the sudden move was prompted by buying by state banks at the behest of the central bank.

"The Chinese central bank's purpose was to narrow the gap between the offshore and onshore rates, but I don't see any fundamental that supports yuan appreciation against the dollar going forward," said Penny Chen, a fixed-income fund manager at Manulife Asset Management in Taiwan.

Since the Aug 11 devaluation, several investment banks, including Goldman Sachs, Morgan Stanley and UBS, have revised down their forecasts for the yuan's performance this year.

The Chinese currency will remain under pressure as long as US interest rates are set to rise, analysts said. US market rates have already risen in anticipation the Federal Reserve will raise its policy rate by the end of this year for the first time since 2006.

In contrast, the Chinese central bank has cut lending rates five times since last November and analysts expect further easing of monetary policy to support China's economy.

The interest rate differential will be reflected more in the offshore market, where China's central bank has less influence, analysts said.

The offshore yuan was quoted at 6.4150 per dollar late on Friday in Asia, compared with an onshore rate of 6.3740 - a gap of 410 pips.

It was 200 pips earlier in the day, but traders said the gap widened after London offshore markets kicked into action.

Some traders believe the central bank will not allow the gap to widen to 500 pips for fear that would strengthen expectations of further yuan depreciation.

Still, the central bank has less influence in the offshore market, which is more driven by market forces, and so leaves more room for the yuan to fall, said Liao Qun, China chief economist at Citic Bank International in Hong Kong.

"The gap between CNH (offshore) and CNY (onshore) will be widened to 500-600 pips again in the coming months," Liao said.

Liao expected the onshore and offshore rates to fall to 6.45 and to more than 6.5 per dollar, respectively, by the end of the year if the Fed increases its benchmark rates.