The yuan briefly hit a record high on Friday, extending its recent strength as further U.S. quantitative easing weakens the U.S. dollar and sparks interest in riskier assets such as emerging market currencies.
The Chinese currency also scored its biggest monthly gain this year, rising 1 per cent in September, with its unusual strength on Friday alone being linked to strong corporate demand for yuan and banks' efforts to avoid carrying short yuan positions over the long holiday next week, traders said.
Some traders also suspected that state banks might have supported the yuan on behalf of the People's Bank of China at the end of the quarter. The central bank typically window dresses the yuan's value at the end of a period in a tactic to avoid direct collision with U.S. critics who say the yuan is deliberately kept undervalued, jeopardizing U.S. jobs.
Spot yuan closed at 6.2849 versus the dollar, up about 0.3 per cent from Thursday's close of 6.3025, after hitting an intraday high of 6.2835, its strongest level since China established the domestic foreign exchange market in 1994.
Before trading began, the PBOC set the yuan's midpoint at 6.3410, slightly stronger than Thursday's 6.3459.
The yuan has now appreciated 0.1 per cent so far this year, regaining all the ground it lost earlier in the year, but traders believe the PBOC may act to cool renewed zeal for the currency and could even intervene in trading to curb the pace of its appreciation amid a sharp slowdown of China's exports.
"QE3-driven risk interest continues fermenting," said a trader at a European bank in Shanghai, referring to the latest bout of bond buying by the U.S. Federal Reserve.
"But we don't believe the yuan has much room to appreciate, as the authorities need a relatively stable currency to prevent a further slowdown in China's exports."
Another trader at a Chinese city commercial bank said:
"Today the important factor has been customer demand, because accumulated foreign exchange settlement was relatively high. There was no demand for dollars, so the market (for dollars) plunged."
A three-month stretch of dollar strengthening from late April had pushed the yuan to depreciate as much as 1.6 per cent by late July, but the currency has since recovered all its lost territory.
Until the fourth quarter of last year, when China's slowing economy began sapping the yuan's appreciation momentum, the PBOC had constantly intervened in trading to prevent the yuan from rising too sharply or too rapidly since the currency's landmark revaluation in July 2005.
Now that QE3 appears to have driven the yuan back onto an appreciation track, the central bank could be vigilant against the renewed threat of an ever-rising yuan to the country's exports, traders said.
"We must closely monitor the impact of recent, new European and American bailout and stimulus steps," the central bank said in its latest policy statement published earlier this week.
Bullish bets on the Chinese yuan rose to their highest level in five months over the last two weeks, even as investors slashed long positions in most emerging Asian currencies, a Reuters poll showed on Thursday.
Positive bets on the yuan increased to their highest level since late April, as investors reduced bearish calls on the currency before a week-long Chinese holiday next week, sending it to a five-month peak versus the greenback.
In trading this week, the yuan also was under upward pressure due to banks' desire to avoid carrying short yuan positions through the holiday that kicks off with the Mid-Autumn Festival this weekend and will last until Oct. 8.
Carrying such a position would be expensive because it would require borrowing yuan in the forex swap market. Such swaps are currently expensive due to tight yuan liquidity in the domestic money market, traders said.
The cost of carry would also be heightened by the length of the holiday as the swap would be needed for a longer duration.