UPDATE 1-Yuan slumps after China threatens retaliation over consulate closure in U.S.

(Recasts with market reaction to China foreign ministry comments, onshore close)

SHANGHAI, July 22 (Reuters) - China’s yuan slipped on Wednesday after Beijing threatened to retaliate against an order by Washington to close the Chinese consulate in the U.S. city of Houston.

A spokesman for China’s foreign ministry said that the order by the United States was an “unprecedented escalation of its recent actions against China” and that China would retaliate if the U.S. did not change course.

After breaching their highest levels in more than four months against the dollar in morning trade, China’s onshore and offshore yuan weakened sharply on the news, falling past the closely watched 7-per-dollar level.

The onshore spot yuan ended its domestic trading session at 7.0059 per dollar, its weakest closing level in more than a week. The offshore yuan stood at 7.0135 per dollar around 0845 GMT, down nearly 0.6% on the day.

“Previously, everyone’s default premise was that there wouldn’t be any escalation in political risk before September ... the impact (of this) on the market’s previous expectations for appreciation has been quite significant,” a foreign bank trader said.

The yuan’s slump came after the currency firmed to its strongest level against the U.S. dollar in more than four months earlier in the session, nearly recouping all of its losses so far this year.

The dollar had fallen against most currencies after European Union leaders agreed on a region-wide rescue plan on Tuesday, boosting hopes of an economic recovery, while political wrangling in Washington appeared to be delaying the next round of U.S. stimulus even as new coronavirus cases continued to mount.

On Wednesday morning, the dollar index stood near more-than-four-month lows.

With its daily midpoint rate set at 6.9718 per dollar, its strongest level since March 12, spot yuan opened at 6.9722 per dollar and strengthened to a peak of 6.9649 per dollar, its highest level since March 11, before paring gains.

The offshore yuan also hit its strongest point since March 11.

Kevin Wu, head of global markets at Hang Seng Bank in Shanghai, said it was important to monitor the Sino-U.S. relationship, but that he maintained his mid-term view of yuan strength.

“Against the backdrop of a highly accommodative Fed and the return of global risk appetite, the dollar will remain under pressure,” he said, adding that China’s stronger economic recovery and the relatively high risk-free yield of yuan assets would also support the yuan.

Reporting by Andrew Galbraith, Jindong Zhang and Winni Zhou; Additional reporting by Xiao Han in Beijing; Editing by Kim Coghill and Rashmi Aich