China's yuan eases on hawkish Fed, warning of depreciation pressure

SHANGHAI, Jan 6 (Reuters) - China's yuan eased against the dollar on Thursday, dragged lower by investor worries over capital outflow risks and depreciation pressure after the Federal Reserve indicated it would tighten monetary policy at a faster pace than markets had expected.

Fed policymakers said at their December meeting that the U.S. labor market was "very tight" and the central bank may need to not just raise interest rates sooner than expected but also reduce its overall asset holdings to tame high inflation, according to minutes of the Dec. 14-15 policy meeting. read more

Fed tightening could affect global fund flows, boosting the dollar and piling pressure on emerging market currencies, traders said.

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Prior to the market opening, the People's Bank of China (PBOC) set the midpoint rate at 6.3728 per dollar, 51 pips firmer than the previous fix 6.3779.

In the spot market, the onshore yuan opened at 6.3711 per dollar and was changing hands at 6.3742 at midday, 95 pips weaker than the previous late session close.

"The expectation of the Fed's tightening trajectory is likely to dominate the dollar's movements," China Construction Bank said in a note.

"The looming interest rate hikes will lift the short-end dollar rates and likely drive the dollar index higher. With the impact of seasonal FX settlement fading, monetary policy divergence between China and the United States is likely to put some downside pressure on the yuan this year."

The bank expects heavy corporate FX conversion to ebb after the Lunar New Year holiday, which runs from Jan. 31 to Feb. 6 this year, while corporate dollar demand should slowly pick up amid strong dollar prospects.

Separately, Financial News, a PBOC-backed newspaper, also warned of depreciation pressure on the yuan, attributing the weakness to shrinking yield advantages, a strengthening dollar, a narrowing trade surplus and uncertainties in global markets. read more

Expectations of a shrinking yield gap between the world's two largest economies were also reflected in the forwards market, with the one-year dollar/yuan swaps point falling to the lowest level since last January.

By midday, the global dollar index rose to 96.193 from the previous close of 96.171, while the offshore yuan was trading at 6.3794 per dollar.

The yuan market at 0401 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 percent from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

*Premium for offshore spot over onshore

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

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Reporting by Winni Zhou and Andrew Galbraith; editing by Richard Pullin

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