Chinese Yuan Advances to Strongest Since End of Dollar Link

The yuan rose to the strongest since a peg to the dollar was scrapped in July 2005, after the central bank reiterated its pledge to maintain a "tight" monetary policy this year.

The currency headed for the biggest three-day gain since the end of the dollar link, after advancing 7 percent in 2007, double the pace of the previous year. The central bank will further control liquidity and improve the currency exchange mechanism in 2008 to "adjust overall demand and improve the balance of international payments," Governor Zhou Xiaochuan said in a New Year's message on the bank's Web site on Dec. 29.

The yuan's appreciation "is likely to continue this year" as a response to "both domestic and external pressure," said Huang Yiping, chief Asia economist at Citigroup Inc. in Hong Kong. The Chinese government needs "to be more aggressive on monetary tightening" to address "the rising inflationary pressure and the risk of overheating," Huang said.

The yuan rose 0.12 percent to 7.2951 per dollar as of 11:48 a.m. in Shanghai, according to the China Foreign Exchange Trade System. The currency gained last year as the country's policy makers sought to curb inflation and reduce a record trade surplus.

"The appreciation will be faster in the first half of this year and slow towards the end of 2008," said Nizam Idris, a currency strategist at UBS AG in Singapore. "We don't think China is looking to slow the economy down but it needs to tighten monetary policy to curb inflation."

U.S. Trade Deficit

China's inflation rate accelerated to an 11-year high in November, fueled by export-led economic expansion. The nation's trade surplus, which rose 52 percent in the 11 months through November to $238.1 billion, has driven foreign-exchange reserves to a record $1.46 trillion, making it difficult for the government to slow growth and tame asset-price inflation.

The U.S. trade deficit with China last year is still set to exceed the all-time high of $232.5 billion in 2006, prompting lawmakers including Senator Charles Schumer, a New York Democrat, to propose sanctions unless yuan controls are loosened. U.S. Treasury Secretary Henry Paulson on Dec. 19 called for faster currency gains, while refraining from accusing China of manipulating its currency to make exports more competitive.

Citigroup's Huang said the pressure from the U.S. is likely to escalate this year because of the weakening U.S. economy and the presidential election.

The median estimate of 28 analysts surveyed by Bloomberg News is for a yuan rate of 6.89 per dollar by the end of 2008. Forward contracts show traders are betting on an 9 percent advance in the yuan to 6.6815 in the next 12 months.

Treasury Bonds

Chinese government bonds were little changed before the nation's lenders, the biggest buyers of government debt, decide on investment plans for 2008.

"Big banks will set the basic tone for this year's investment in late January, probably before the Chinese New Year," said Dong Dezhi, a fixed-income analyst with Bank of China Trading Center in Shanghai. "Before that, no significant change will take place in the debt market."

The benchmark interbank seven-day repo fixing increased 0.26 percentage point to 2.86 percent, according to the National Interbank Funding Center. The Shanghai interbank offered rate, or Shibor, for one-month funding rose 0.07 percentage point to 3.68 percent to reflect rising cash demand before the Chinese New Year starting the second week of February.

The yield on the treasury note due in May 2012 held at 2.88 percent, according to the China Interbank Bond Market. The price of the 3.37 percent security was little changed at 101.99 per 100 yuan face amount.