SHANGHAI, July 19 (Reuters) - China's yuan edged up against the dollar on Tuesday after breaching the key level of 6.7 per dollar in the previous session, with state banks stepping in to control the slide. Many market watchers expect the central bank will allow the yuan to weaken further in coming months if the economy continues to struggle, though some believe it may allow a more gradual decline after a sharp 3 percent fall so far this year. While China's second-quarter economic growth data on Friday was slightly stronger than expected due to growing central government support, exports continued to fall and investment is cooling rapidly, keeping fears of capital outflows alive. The yuan slipped below the psychologically important 6.7 level for the first time in more than five years on Monday after state-bank support for the currency tapered off in late trade. On Tuesday, spot yuan opened at 6.7011 and was at 6.6988 at midday, up 0.05 percent from the previous close. The yuan's sharp decline over the last year has added to a wall of worry for investors already rattled by slowing global economic growth and the potential fallout from Britain's decision to leave the European Union. Fitch Ratings warned on Tuesday that China's increasing reliance on debt-fuelled stimulus was also adding to the risks facing its banking system. The yuan's brief slide past the 6.7 milestone came on the eve of the U.S. Republican National Convention, where presumptive presidential nominee Donald Trump is to be formally announced. In June, Trump called China a "grand master" of currency devaluations and urged a tax on imports. It also comes just days before China hosts G20 finance ministers and central bank governors, who in April reaffirmed a pledge to refrain from competitive devaluations and not set exchange rates for competitive purposes. Chinese authorities typically have held the yuan steady during similar high-level diplomatic events in the past. Beijing has said repeatedly in the past that it won't use the yuan to gain a trade advantage, adding it is committed to continue "market-oriented exchange rate reform" of the yuan. Since the shock Brexit vote on June 23 roiled global markets, China has allowed the yuan to fall about 1.8 percent against the dollar and more than 1 percent against a basket of currencies of its main trading partners. On Tuesday, the People's Bank of China set the midpoint rate at 6.6971 per dollar prior to the open, only 0.01 percent weaker than the previous day's fix of 6.6961. Traders and analysts said Tuesday's midpoint was firmer than their models suggested, with one trader saying the official guidance rate missed his bank's estimate by over 50 pips. The central bank sets the midpoint each day based on a number of factors, including the previous day's rate, but it is widely believed to have a degree of discretion to move the rate up or down as it sees fit. Traders said state banks were determined to defend the yuan at 6.6990 on Tuesday by selling dollars. "It seems to me China's central bank has put a brake on CNY depreciation, at least temporarily," Zhou Hao, senior emerging markets economist at Commerzbank AG in Singapore, said in a note. "Market outlooks on the yuan are diverging at this point, with some saying the firm stance from the central bank showed not much room for further depreciation, but others seeing more in coming months," said a trader at a European bank in Shanghai. Quoting policy sources, Reuters reported earlier this month that Beijing would tolerate a fall in the yuan to as low as 6.8 per dollar in 2016. That would equate to fall of 4.5 percent for the year, the same as last year's record decline. A Reuters replica tracking the index for the yuan's value against a trade-weighted basket of 13 currencies stood at 94.44 on Tuesday, down 6.44 percent for the year. Kevin Lai, chief economist Asia Ex-Japan at Daiwa Capital Markets in Hong Kong, said in light of the possibility that Trump might win the U.S. election in November, now was not a bad time to let the yuan shed some value. "If that's the case and I were a Chinese policymaker, I would let the currency move sooner rather than later," said Lai. Yuna Park, currency and bond analyst at Dongbu Securities in Seoul, expects the yuan to weaken to 6.8-6.9 by year end. "The PBOC is unlikely to stop the yuan's weakness although it may slow down the speed of depreciation. Although China emphasises domestic demand, the economy is still export-oriented. "Other emerging Asian countries may want their currencies to be weaker to improve their current accounts. They will not use foreign exchange reserves (to support their currencies)." The offshore yuan was trading 0.18 percent softer than the onshore spot at 6.7108 per dollar. The central bank was suspected of intervention in the offshore market last week to ease depreciation pressure on the Chinese currency. The Financial News, a paper owned by China's central bank, said on Monday that the yuan is to remain relatively stable. The yuan market at a glance: ONSHORE: Item Current Previous Change PBOC midpoint 6.6971 6.6961 -0.01% Spot yuan 6.6988 6.7019 0.05% Divergence from 0.03% midpoint* Spot change YTD -3.06% Spot change since 2005 23.55% revaluation *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 percent from official midpoint rate it sets each morning. OFFSHORE CNH MARKET Instrument Current Difference from onshore Offshore spot yuan 6.7108 -0.18% * Offshore 6.852 -2.26% non-deliverable forwards ** *Premium for offshore spot over onshore **Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. . (Reporting by the Shanghai Newsroom and Nathaniel Taplin; Editing by John Ruwitch and Kim Coghill)
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