Economic Watch: Yuan strength reveals market confidence in Chinese economy

The Chinese yuan strengthened against the greenback Wednesday, extending gains to hit a 16-month high and notching the largest daily surge since April 8 this year.

The central parity rate of the yuan strengthened 397 pips to 6.7825 against the U.S. dollar Wednesday, according to the China Foreign Exchange Trade System (CFETS).

The yuan surged in both onshore and offshore trading. The offshore yuan strengthened to its highest level in 16 months, rising more than 5 percent since the end of May.

Market optimism, building on the resilience and long-term prospects of the Chinese economy, has fueled the yuan's rally to gain steam over the months, analysts said.

Latest data showed China's industrial output expanded at a faster pace in August, while retail sales, a main gauge of consumption, rose for the first time this year.

Other leading indicators, including the purchasing managers' index, electricity consumption and excavator sales, all pointed to further recovery in economic activities after the country brought the COVID-19 epidemic under control.

The country's economic performance has been quite convincing, with the turnaround in the second quarter of the year and a likely momentum gain in the third quarter, reinforcing investors' expectations of a stronger yuan, said Zhao Qingming, a specialist in international finance.

The country's economy expanded 3.2 percent year on year in the second quarter, bouncing back from a contraction of 6.8 percent in the first quarter.

Fu Linghui, spokesperson of the National Bureau of Statistics, said the country's economic growth is likely to undergo "an evident acceleration" in the third quarter if recovery momentum continues in September.

The country's exports posted the first increase this year from January to August, indicating the impact of COVID-19 on economic growth, especially on foreign trade, has been contained, adding to market confidence in the economy and fueling expectation of a stronger yuan, said Tu Yonghong, deputy chief of the International Monetary Institute of Renmin University of China.

The CFETS yuan exchange rate composite index, which measures the yuan's strength relative to a basket of currencies, came in at 93.6 on Sept. 11, up from 91.39 at the end of 2019.

A weak U.S. dollar and a widening spread between the two economies' interest rates have driven the yuan to appreciate, said Xu Gao, chief economist at Bank of China International.

The dollar index, which measures the greenback against six major peers, was down 0.01 percent at 93.0501 overnight. It has declined more than 9 percent from this year's peak in March.

China's continued efforts in opening up its financial markets also made international investors upbeat about the economic outlook and yuan-denominated assets, leading to inflow of international capital and support in strengthening the yuan, analysts said.

In the short run, factors including China's economic recovery and increasing capital inflows will continue to push up the yuan exchange rate, said Wen Bin, chief analyst at China Minsheng Bank.

In the longer term, however, as the formation mechanism of the yuan's exchange rate becomes more market-oriented, it will maintain two-way movement within a balanced and reasonable range, Wen said.

In China's spot foreign exchange market, the yuan is allowed to rise or fall by 2 percent from the central parity rate every trading day.

The central parity rate of the yuan against the U.S. dollar is based on a weighted average of prices offered by market makers before the opening of the interbank market on each business day.