China Money: Forwards seen overpricing yuan vs dollar

By Lu Jianxin and Karen Yeung

SHANGHAI, March 12 (Reuters) - The forwards markets have been implying the yuan will appreciate an eye-popping 12 percent against the U.S. dollar over the next 12 months.

But few traders and analysts in Shanghai think that will happen. As the dollar has tumbled globally and Chinese inflation has risen in the past couple of weeks, they say forwards have begun seriously overpricing the currency.

"Markets have grown too pessimistic over the dollar's fall," Shi Lei, an analyst at Bank of China, the country's top foreign exchange bank, said in a research report this week.

"For the yuan, we forecast a trend of obvious slowdown in its appreciation in the third and fourth quarters, and maintain our forecast for the yuan to rise around 8 percent for all of this year," he said, adding appreciation would slow further in 2009.

The offshore non-deliverable forwards (NDFs) market on Monday implied a 12.40 percent rise of the yuan against the dollar over the next 12 months.

That was the highest implied appreciation since the yuan's CNY=CFXS peg to the dollar was abolished in July 2005, and up from levels below 9 percent as recently as February. On Wednesday afternoon, implied appreciation was 12.00 percent.

The yuan has also soared in the onshore forwards CNY1YOR= market. Implied 12-month appreciation there hit a record 11.95 percent on Monday. It was 10.94 percent on Wednesday.

The rise was especially dramatic because it occurred as the China-U.S. interest rate gap was widening, which in normal conditions would have tended to restrain the yuan in forwards markets. The spread of the one-year Chinese central bank bill yield CN1YNFIX=R above one-year dollar LIBOR LIUSD1YD= is now about 150 basis points.