Yuan bounces from 5-month low after PBOC pledges to keep market stable

China's yuan clambered off a five-month low against the dollar on Monday, after the central bank pledged to do its utmost to prevent large fluctuations in the currency.

Investors have refrained from aggressively testing new lows for the yuan after the central bank on Friday vowed to curb speculation and urged key participants to keep the foreign exchange market stable, traders said.

More action might be taken to prevent rapid yuan depreciation following the verbal warnings, they added.

On Friday, major state-owned banks were seen swapping yuan for dollars in the onshore forwards market - a sign that authorities were trying to manage the rapid fall in the currency.

Prior to Monday's opening, the People's Bank of China (PBOC) set the midpoint rate USDCNY at 7.0157 per dollar, 199 pips or 0.28% firmer than the previous fix of 7.0356.

That was 16 pips weaker than a Reuters estimate of 7.0141.

In the spot market, the onshore yuan USDCNY was changing hands at 7.0175 per dollar at midday, compared with 7.0615 - its lowest point in more than five months - hit on Friday.

Implied volatility (CNY1MO=), an options market gauge of future volatility, also stabilised in morning deals after sharp rises last week.

Despite the rebound, traders expect the yuan may continue to stay on the weaker side of the key 7 per dollar level in the near term as seasonal dividend payments would start to flow through soon.

Overseas listed Chinese companies usually have higher FX demand between May and June to make dividend payments to their overseas shareholders.

Goldman Sachs analysts revised down their yuan forecasts, saying a lack of confidence in China's economy was the biggest risk to the country's recovery outlook for the second half.

"If confidence continues to erode and the negative feedback loop takes hold, a soft patch in Q2 could turn into disappointing growth in subsequent quarters," they wrote in a note to clients.

They predict the yuan to trade at 7.1 per dollar in three months, 7.0 in six months, and 6.8 in 12 months, down from 6.8, 6.7, 6.5.

Yuan weakness and widening yield differentials with the United States have also limited the scope for substantial monetary easing, and China on Monday kept its benchmark lending rates unchanged for a ninth straight month.

Joey Chew, head of Asian FX research at HSBC, said a combination of factors including yield differentials, weaker investor confidence and lack of inflows all contributed to the recent yuan weakness.

"I think it's fair to say there's no particular line in the sand," she said, adding levels including 7 and 7.05 will be closely watched by investors.

By midday, the global dollar index DXY was down at 103.037 compared with its previous close of 103.198, while the offshore yuan USDCNH was trading at 7.0333 per dollar.

The yuan market at 0400 GMT:

ONSHORE SPOT:

Key indexes:

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2% from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

*Premium for offshore spot over onshore USDCNY

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. USDCNY.