China's yuan hovers at 3-1/2-year high, investors cautious

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SHANGHAI, Dec 9 (Reuters) - China's yuan hovered at a more than 3-1/2-year high against the dollar on Thursday on continued year-end seasonal corporate demand, though some investors were growing cautious over how much more more Bejing would allow the currency to appreciate.

The yuan has gained nearly 3% against the greenback so far this year and China's robust export growth is starting to slow, stirring talk over where authorities may draw a "red line" on its advance.

Both the onshore and offshore yuan advanced to cross this year's peak and the psychologically critical 6.35 per dollar on Wednesday to hit the firmest level since May 2018, with analysts and economists attributing the strength to robust exports, a record trade surplus and ample dollar liquidity onshore.

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Prior to the market opening, the People's Bank of China (PBOC) set the midpoint at 6.3498 yuan per dollar, 179 pips, or 0.28%, stronger than the previous fix of 6.3677. It was the firmest since May 15, 2018.

However, the much firmer fixing did not come in as strong as market forecasts, traders said, discouraging the market from testing new highs in the yuan on Thursday morning.

Market participants usually take deviations between their projections and the official fix as a sign of the official attitude on currency movements. The official guidance rate was 46 pips weaker than Reuters' estimate of 6.3452 per dollar on Thursday.

In the spot market, the onshore yuan opened at 6.3468 per dollar and was changing hands at 6.3442 at midday, 4 pips weaker than the previous late session close.

Apart from the weaker-than-expected guidance rate, the state-owned China Securities Journal added another note of caution. It reiterated in a front-page commentary of two-way volatility in the yuan and said that seasonal and transactional factors underpinning the recent rally may not be sustainable. read more

Currency traders said corporate conversion of their FX receipts into the yuan remained heavy to support the Chinese currency in morning deals. Meanwhile, latest stimulus measures, including a cut to banks' reserve requirement ratio (RRR), to prop up the cooling economy also lifted sentiment.

"The recent easing measures by the PBOC spurred risk-on sentiment onshore, and could have contributed to this down-move in the USD/CNH," said Terence Wu, FX strategist at OCBC Bank.

"Going forward, expect to see a new range between 6.3300 and 6.3700 for the pair, with a downside bias."

Helen Qiao, head of Asia economics and chief China economist at BofA Global Research, said the yuan's nominal value has been stronger, but what matters for trade competitiveness is the real exchange rate.

"The current CPI in China is lower than that in the U.S., so appreciation has been more or less offset by the lower CPI, and the underlying situation is better than the strong yuan has suggested."

The U.S. investment bank expected the yuan to finish this year at 6.45 per dollar.

By midday, the broad dollar index rose to 96 from the previous close of 95.942, while the offshore yuan was trading at 6.3425 per dollar.

Data on Thursday showed China's red-hot factory-gate inflation cooled slightly in November, driven by a government crackdown on runaway commodity prices and an easing power crunch, amid Beijing's efforts to lessen the crippling effects of surging costs on the economy.

While factory inflation remains uncomfortably high, the price moderation may give policymakers some latitude to announce more growth support measures. read more

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% 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 Kim Coghill

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