The yuan displayed greater volatility on Monday but steered clear of testing a newly expanded trading band, suggesting investors were comfortable with the current range as Beijing tries to guide the economy through a controlled cool-down.
The yuan closed at 6.3150, down 0.19 per cent from Friday's close. It had opened sharply weaker than the central bank's midpoint fixing, but even at its weakest point remained within the boundaries of the old trading band in effect prior to the recent move announced over the weekend.
It traded as low as 6.3250 per dollar – 0.46 per cent weaker than the midpoint and 0.3 per cent weaker from Friday's close – just within the previous 0.5 per cent limit and well shy of the new 1 per cent band that went into effect Monday.
"We think this decision reflects PBOC's desire near-term for greater two-way price action and intra-day volatility... to better cope with more volatile and somewhat smaller balance of payment inflows into China," Barclays analyst Olivier Desbarres said in a note to clients.
The yuan weakened in opening trades as some dealers anticipated downward pressure due to the dollar's global strength.
Before trading began, the central bank set its daily midpoint at 6.2960, weaker than Friday's fixing of 6.2879. The fixing followed the bank's normal pattern of setting a weaker midpoint in response to a rise in the dollar index overnight.
A weaker currency would provide a cushion for exporters struggling with flagging demand from Europe and the United States, China's two biggest trading partners.
But Beijing has a history of allowing the currency to rise ahead of major international gatherings, and there are two coming up. The International Monetary Fund's meetings are next week, and the Strategic and Economic Dialogue between the United States and China is expected in early May.
The yuan has consistently traded weaker than the central bank's midpoint since mid-March, leading some to anticipate broader depreciation following the central bank's move giving the yuan more freedom of movement.
The midpoint fixing is the base rate that the central bank uses to flag the government's intentions for the yuan's value.
The recent trend of the yuan trading weaker than the midpoint is a result of dollar strength amid the euro crisis, traders say.
"Recently, the euro is weakening, dollar index has been consistently rising, people see the midpoint rising in response, so it's normal for people to take a bit of a (long dollar) position," said a trader at a joint stock bank in China.
He added that expectations of the currency's movement would now be based more on signals from the market rather than expectations about central bank policy.
The immediate impact on the market's daily operations is likely to be limited. The yuan has not hit the boundaries of the previous 0.5 per cent trading band at all in 2012.
Daily movements have been mostly confined to a range of 100 to 200 pips, or about 0.2 to 0.3 per cent, on the China Foreign Exchange Trading System (CFETS), the China's main onshore forex trading platform.
But volatility is likely to increase gradually. Traders expect that the People's Bank of China's widening of the band will mean the currency eventually moves more than 200 pips a day, possibly even 400 pips on occasions, over the next 12 months.
"Market movements will become sharper. It also shows the central bank's attitude – they will not try to control market volatility. We will live or die by our own skill," said a trader at a European bank in Shanghai.
The widening, which was widely expected, has also not altered market expectations of a gradual yuan appreciation of around 2 to 3 per cent this year, traders said.
Though the immediate impact will be limited, some analysts also saw the move as a signal of further pro-market reforms in the pipeline.
"This move also implies that Beijing sees now as the right time for pushing forward some key financial reforms," Qu Hongbin, co-Head of Asian Economics Research for HSBC.
"Chief among the financial reforms is capital account liberalization. This will also be mutually supported by further reform actions in RMB internationalization, domestic bond markets and banking sector," he said, referring to the yuan using an abbreviation for renminbi, an alternate name for the currency.
Still, some traders cautioned that the move does not alter the fundamental nature of China's onshore forex market, which remains tightly controlled by the central bank.
"Actually, even after this expansion, control is still in the hands of the central bank. The impact isn't that large," said the joint stock bank trader.
Indeed, the widening of the band would not prevent ad hoc interventions in the market by the central bank in response to sharp swings. Such interventions can be difficult to confirm, but traders and analysts widely believe they occur periodically.