* Firms retain more dollars on hand after yuan fall
* Focus shifts to corporate dollar demand from policy
* PBOC cuts frequency of large-scale intervention
* But traders expect continuing daily guidance on yuan
By Lu Jianxin and Pete Sweeney
SHANGHAI, July 18 China's central bank has
reduced heavy intervention in the currency market, removing a
thorny issue in relations among the world's top two economies,
but traders say the People's Bank of China (PBOC) isn't about to
take its hands off the wheel.
Chinese firms, including banks, have increasingly held on to
dollars as capital inflows into China slow as a result of
slowing economic growth and particularly after the PBOC let the
yuan surprisingly fall in the first four months of 2014.
The rough balance of dollar supply and demand in the market
as a result of these developments will enable the central bank
to reduce the frequency of its operations to control the yuan's
exchange rate in future.
But the PBOC -- with a trading room of its own in the China
Foreign Exchange Trade System and often acting via state banks
-- is likely to keep quoting the yuan every day and conducting
routine trading through which it can guide its movements and
prevent its value from running out of control, traders said.
"All data points to evidence that the central bank has
indeed reduced its intervention into trading to influence the
value of the yuan in recent months," said Liu Dongliang, a
currency strategist at China Merchants Bank in Shanghai.
"Market anticipation of the yuan's future value has changed
a lot after the yuan's unexpected depreciation earlier this
year, with firms more reluctant to sell dollars they earn.
"Still, the PBOC's daily activity will last at least for
another couple of years as the market learns to operate without
the central bank's guidance, among other reasons."
PBOC Governor Zhou Xiaochuan said this month during the
annual U.S.-China Strategic and Economic Dialogue that China
would "significantly" reduce its yuan intervention when some
prerequisites are met. U.S. officials say China
deliberately holds down the yuan to boost its exports, an
accusation China denies.
WHAT DOES DATA SHOW?
The PBOC engineered a fall in the yuan earlier this year,
guiding it down by as much as 3.4 percent by the end of April,
to dampen speculative bets on one-way yuan appreciation.
Since May, however, the central bank has shifted to holding
the currency steady, suggesting that its drive to guide the yuan
lower was largely over, although the yuan is still down 2.5
percent so far this year.
China's trade surplus widened sharply to a five-year high of
$35.9 billion in May from April's $18.5 billion, but Chinese
banks posted a surplus of only $6.8 billion in their foreign
exchange settlements for their clients in May -- the smallest in
10 months and the fourth straight month of falls.
That indicates that Chinese corporates are retaining much of
their foreign currency earnings, partly reflecting changed
market views of the yuan's future value, traders said.
"Reflecting the new trend, the market has now shifted its
attention more toward real dollar demand from corporate orders
and away from policy factors," said a dealer at a European bank
As a result, the PBOC and commercial banks together bought
just 38.7 billion yuan ($6.22 billion) of foreign exchange on a
net basis in May, down from 116.9 billion yuan in April, the
lowest level since last September. The dip reflects less capital
inflows into China, traders said.
More surprisingly, the PBOC's foreign exchange assets only
edged up 361 million yuan in May, down from an already thin 84.6
billion yuan rise seen in April, the lowest growth since July
last year. The increase and decrease in its forex assets reflect
its dollar purchases and sales in the yuan market.
Compared with overall banks' dollar purchases, the virtually
flat PBOC forex assets show that commercial banks have also
tended to keep more dollars on hand.
"These data points are supported by others," said a trader
at a major Chinese commercial bank in Shanghai.
"Banks' forex deposits and loans have also showed corporates
increasingly retaining dollars as assets while denominating
liabilities in yuan."
($1 = 6.21 Chinese yuan)
(Editing by Jacqueline Wong)