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BEIJING (MNI)

The yuan may be approaching its high point for this year, sources familiar with People's Bank of China exchange rate policy told MNI, noting that the currency's strength at a time of broad dollar weakness may indicate an official desire to boost local capital markets by allowing inflows but that the exchange rate was beginning to pressure exporters.

USDCNY, which closed at 6.8450 to the dollar at 11 am Beijing time Friday, down from the year-high 7.1765 at the end of May, may fluctuate between 6.75-6.85 for the rest of 2020, said a source, adding that the currency may have embarked on a medium-term appreciation trend. But, while stronger-than-expected export demand has given authorities more tolerance for yuan strength as foreign investors chase relatively high-yielding Chinese government bonds, there is a danger that trade and inventory indicators will begin to show strain, he said. The PBOC will need to retain capital controls and the counter-cyclical factor in the yuan forex formation mechanism, he noted.

While it is possible the yuan could gain some more ground this year, the broad-based dollar weakness which has driven its appreciation may be running out of steam, the source said, adding that even should the dollar index fall as low as 90 from its current 93, the yuan would be unlikely to break 6.7 against the greenback. The source last spoke to MNI on Aug. 19, when he said the yuan could strengthen to as much as 6.7-6.8 from its then level of 6.91 on the back of China's economic rebound.

In the longer run, there will be a tendency for Chinese authorities to tolerate broader ranges of yuan fluctuation, as the country further opens its financial markets, he said. Another advisor agreed, noting that the government's new "dual circulation" strategy, which emphasises domestic demand, is likely to see a fall in China's current account surplus over time.

YUAN TRADE GOES GLOBAL

Another factor may also be coming into play as the yuan strengthens, the second source said, noting that as the increasing internationalisation of the yuan has shifted a greater proportion of offshore trade in the currency to Singapore and London, and away from Hong Kong where many players are linked to the Chinese government, it has become harder for the PBOC to impact the exchange rate. This has become particularly apparent since last year, she said.

The PBOC's daily USDCNY fixing has risen by 4.2% since the end of May, as the yuan appreciated by about 5%. The dollar index has retreated nearly 10% since March.

While the second source agreed that the end to broad dollar weakness was likely close, with the euro in particular lacking fundamental support, she stressed that the yuan would probably not weaken back below 7 to the dollar this year barring a global resurgence of Covid-19 or a further significant deterioration in U.S.-China relations.

She noted that the Chinese currency's appreciation has occurred as China implements its Phase 1 trade deal with the U.S., under which it committed to refrain from using its currency to seek competitive advantage. This consideration may also have influenced PBOC actions, she said.

An improving U.S. economy in the third quarter could help the dollar index recover to about 95 by October, said a trader at a state owned bank, adding that USDCNY is likely to find strong support at 6.8.

Thursday's USDCNY close saw it ease from 6.8261 Wednesday. On Friday, the PBOC set the daily fixing at 6.8359, snapping a run of eight consecutive stronger fixes.

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