LONDON Feb 13 (Reuters) - A Bank of England pledge to help London become a global trading centre for China's yuan has stirred talk of a revival in the city's fortunes, similar to the explosion of the U.S. dollar market in the 1960s and 70s.
In what many bankers saw as a pivotal move, the British central bank said last month it was ready "in principle" to adopt a currency swap line with the People's Bank of China, providing a two-way pipe to the City as the still-unconvertible yuan starts to emerge as a world reserve currency.
Britain would become the first major developed economy to install a currency swap line with China, replicating existing arrangements available for the dominant freely-traded currencies such as the dollar, euro and Japanese yen.
China has agreed swap lines with more than 15 other countries but these tend to be emerging economies that have natural resources or goods used in manufacturing to export. The list does not include major industrial powers such as the United States, euro zone countries or Japan.
However, in a deliberate push to internationalise the yuan, or renminbi, China has been developing an offshore market for it, as a precursor to allowing global firms, banks and asset managers access to its domestic market.
China plans to make the yuan basically convertible as early as 2015 and eventually put it on a par with the U.S. dollar.
Britain's commitment to a swap line with the world's second biggest economy should boost fledgling trade in the offshore yuan in London, market watchers say, helping it to see off rival yuan centres such as Frankfurt, Paris and New York.
A swap line between Britain and China would allow the Bank of England to supply yuan in exchange for other currencies if there were a sudden shortage in the London market, enabling a British company, for example, to pay for Chinese imports.
But if markets function well, there would be no need to use it. Many of the PBOC's swap lines have not been used.
"I see it as a big signal to all market participants that the City of London and UK are taking this very seriously," said John McCormick, chairman of RBS Asia Pacific. "It's as important as the development of the Eurodollar market 40 years ago."
London positioned itself as a natural hub for global foreign exchange and money market trading in the 1960s and 1970s, before the offshore dollar, or Eurodollar, took off as free-floating currencies replaced the gold standard in 1973.
Boosted further by a combination of market deregulation and transformation of trading technology in the mid-1980s, known locally as "Big Bang", London boomed as a home for world finance, with the number of foreign banks with branches or offices in the city almost tripling in the 30 years to 1999.
While many fretted a year ago about how far the credit crisis might undermine London's role, British finance minister George Osborne launched a campaign to capture yuan business.
But convincing British or other European companies to invoice in yuan for the goods they sell to China, or to issue yuan bonds, has not always been easy, market participants say.
The yuan is only the world's 16th currency for payments, according to global transaction services organisation SWIFT, and the yuan's position in global reserves is still tiny.
The swap line was top of London bankers' wish lists but hopes the central bank would grant it had not been high.
"It was a bit of a bolt from the blue," said Andrew Malcolm, head of capital markets for Asia at law firm Linklaters, describing the decision as "an opportunity for London to establish itself as the pre-eminent renminbi centre in Europe."
Despite the U.S. appetite for Chinese goods, it is Britain that handles the world's biggest share of renminbi payments outside China and Hong Kong, according to SWIFT, at 28 percent compared with 4 percent handled in the United States.
London is the world's biggest foreign exchange and bond trading centre and Britain is hoping for an offshore yuan bond market to replicate the explosion in such business in Hong Kong, Asia's main offshore yuan centre.
There have only been a handful of yuan bonds launched in London, but issuance of offshore yuan, or "dim sum", bonds in Hong Kong is expected to rise this year by 20 to 30 percent, to as much as 350 billion yuan ($56 billion) including certificates of deposit, according to Standard Chartered estimates.
Daily offshore yuan trading in London rose 150 percent in the year to June 2012, to $1.7 billion, according to a recent survey by Bourse Consult for the City of London.
However, yuan deposits, recorded as totalling 109 billion yuan at end-2011, suffered from depreciation of the yuan in early 2012, and had also been overstated due to misreporting by some banks. The interbank and corporate deposit total collated by Bourse Consult shrank to 15 billion yuan in June 2012.
Bankers may now look further down their wish lists and seek a British sovereign yuan bond.
To spur the market further, Britain could launch a yuan bond in China, China could issue an offshore yuan bond in London, or London could settle trades directly, rather than via Hong Kong.
Other Chinese borrowers could also launch more yuan bonds in London, following a sole Chinese issue last year.