A sharp rebound in the strength of Chinese currency the yuan has mitigated worries of further depreciation and shored up the credibility of an exchange rate system that is becoming more market-based.
The central parity rate of the yuan opened 141 basis points higher at 6.5552 against the U.S. dollar on Thursday after plunging to the lowest level since March 2011 on the previous trading day.
The strong performance ended rising market speculation of a falling streak backed by the government. The yuan has been lackluster since early this month.
"It is merely a normal response to the appreciation of the U.S. dollar," said Han Huishi, a veteran foreign exchange analyst, dismissing rumors that China's central bank was trying to unleash downward pressures on the currency.
There has been growing expectation of a U.S. Federal Reserve rate hike, leading to a surge in the U.S. dollar and weak performance of non-dollar currencies. The U.S. dollar index, which reflects the value of the dollar relative to a basket of currencies, has increased nearly 3 percent from the beginning of this month.
Federal Reserve minutes released in April showed the U.S. central bank may raise interest rates earlier than expected if the economy continues to improve.
"Given the possible rate hike, the U.S. dollar is likely to remain strong in the next two years, which will lead to continued pressure on the yuan," said Zheng Liansheng, a researcher with the Chinese Academy of Social Sciences.
Morgan Stanley's chief Asia economist Chetan Ahya said he expects the yuan to drop by around 4 percent to 4.5 percent against the U.S. dollar, while some other analysts, including Han, think the room for depreciation will be quite limited.
The yuan started a volatile journey after the People's Bank of China changed the exchange rate mechanism last August to make it more market-oriented and close a price spread between onshore and offshore trading of the currency.
"As the market has been allowed to play a bigger role, the yuan's value will see greater volatility, either ups or downs, in the future," said Zhao Xijun, vice president of the finance school of Renmin University.
One of the world's largest trading nations, China is seeking greater use of its currency in global trade and finance and has promised more efforts to realize yuan convertibility on the capital account.
The International Monetary Fund has approved the yuan's inclusion in its special drawing rights currency basket, a move that analysts expect will grant China more flexibility in the foreign exchange market.
The yuan slipped to the sixth most used currency in global payments in April after the Canadian dollar, Japanese yen, British pound, euro and U.S. dollar, accounting for nearly 1.82 percent of the world's total, according to a monthly SWIFT report.
