Pre-holiday demand supports yuan as China signals more easing

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SHANGHAI, Jan 19 (Reuters) - Seasonally strong corporate demand supported the Chinese currency on Wednesday, but a softer daily fixing and a narrowing spread between Chinese and U.S. yields kept gains in check as the country's central bank flagged further easing.

Chinese bond yields slipped across the curve after the central bank's vice governor said on Tuesday would roll out more policy measures to stabilise the economy amid signs of weakening growth momentum. read more

The drop in yields followed an unexpected cut to China's medium-term lending rate on Monday, and came after benchmark U.S. Treasury yields hit two-year highs as traders bet on more aggressive action from the Federal Reserve to address inflation.

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The combination squeezed the spread between Chinese and U.S. benchmark rates to its narrowest in nearly 32 months.

But traders said demand for the yuan ahead of the week-long Lunar New Year holiday, which begins on Jan. 31, would continue to support the currency in the near term.

"Before the holiday, spot yuan is likely to fluctuate in a narrow range. Narrowing spreads means depreciation in general for the yuan but of course you need to watch the timing," said a trader at a Chinese bank.

Ahead of the market open on Wednesday, the People's Bank of China set yuan's daily midpoint at 6.3624 per dollar, after setting Tuesday's fix at a more than one-month high of 6.3521.

Spot yuan opened at 6.3535 per dollar and firmed to 6.3523 at midday, 14 pips stronger than Tuesday's late night close. The offshore yuan was trading -0.08 percent away from the onshore spot at 6.3575 per dollar.

The offshore yuan firmed to 6.3575 per dollar from 6.3596 on Tuesday.

Despite the pressure from narrowing spreads, Scotiabank analysts said China's significant trade surplus and controlled service trade deficit would continue to support the offshore yuan through the first quarter. They said they expect it to remain in the range of 6.34 to 6.40 with potential for further appreciation, though any strengthening through 6.35 could attract regulators' attention.

China posted a record trade surplus in December and in 2021, as exports outperformed expectations during the pandemic. read more

The Thomson Reuters/HKEX Global CNH index , which tracks the offshore yuan against a basket of currencies on a daily basis, stood at 102.46, firmer than the previous day's 102.29.

The global dollar index fell to 95.721 from the previous close of 95.732.

The yuan market at 4:05AM 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 Andrew Galbraith and Jindong Zhang; Editing by Kim Coghill

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