China may let yuan gain 5% after rate increase

The economy expanded 10.7 percent in the fourth quarter of 2009 from a year earlier. Consumer prices will climb faster than the 1.9 percent pace in December, he said. “Between economic growth and restraining inflation, China's focus is shifting toward controlling inflation,” Kan said. An interest-rate increase alone won't be enough and “China should discuss withdrawing its policy of limiting the yuan's gains,” he said. Since ending the yuan's peg to the dollar in July 2005, the central bank said it would allow it to float with reference to a basket of currencies including the euro, yen and South Korea's won. Policy makers have kept the yuan at about 6.83 per dollar since July 2008, after allowing it to strengthen 21 percent against the dollar in the previous three years.

Twelve-month non-deliverable yuan forwards traded at 6.6875 per dollar, from 6.6820 on Feb. 5 as of 11:22 a.m. in Hong Kong, reflecting traders' bets the currency will advance 2 percent from the spot rate of 6.8273.

Forwards are agreements in which assets are bought and sold at current prices for delivery at a future specified time and date. Non-deliverable contracts are settled in dollars rather than the local currency.

Record lending in the world's fastest-growing major economy pushed consumer prices higher in December by the most in more than a year. The Shanghai Composite Index of shares has dropped 9 percent since China increased the amount of cash banks must set aside as reserves on Jan. 18 for the first time since 2008. The gauge rallied 80 percent last year.

China is keeping currency appreciation in check to help support a recovery in exports, which dropped for 13 straight months before rising in December last year.

Should consumer prices climb as much as 4 percent, that will likely prompt policy makers to tighten monetary policy, Kan said. The People's Bank of China may raise the lending rate by 0.27 percentage point from the current 5.31 percent in June, he said.

China will likely let the yuan strengthen at an annual rate of 4 percent to 5 percent this time, compared with as much as 10 percent during its previous phase of appreciation, Kan said. “With the exchange rate approaching equilibrium, there may be less room for an increase,” he said.

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