THE most accurate forecasters of the yuan predict China's currency will be allowed to strengthen faster in the remainder of 2011 to combat inflation, even as forwards traders bet gains will be the slowest in a year.

The yuan will rise 2.9 percent to 6.28 per US dollar in the second half of this year after climbing 1.9 percent in the first six months, according to Joseph Capurso, a currency strategist at Commonwealth Bank of Australia, which Bloomberg news data show had the best projections for the six quarters through June. Wells Fargo & Co, which ranked second, forecasts a 2.6 percent advance to 6.30. Six-month non-deliverable forwards traded at a premium of as little as 0.3 percent to the spot rate last week.

"Part of our thinking behind yuan appreciation is (that) the Chinese government is using the exchange rate to contain inflation pressures and rebalance the economy towards consumer spending and away from exports," said Sydney-based Capurso, whose projections had an average margin of error of 0.44 percent. "The unfolding public debt crisis in Europe may slow the rate of appreciation in the near term."

As expectations for a yuan appreciation among investors fade, the average yield on yuan-denominated bonds in Hong Kong has jumped 99 basis points, or 0.99 percentage point, to 2.91 percent since the end of April, based on an HSBC Holdings Plc index. The government's policy of limiting currency gains fans inflation by making imports more expensive and draws criticism from China's trading partners led by the United States, which says an undervalued yuan gives Chinese exporters an unfair advantage.

Shrinking Premium

The yuan has gained 0.04 percent this month and touched 6.4563 per US dollar last Thursday in Shanghai, the strongest level since the country unified official and market exchange rates at the end of 1993, according to the China Foreign Exchange Trade System. Brazil's real fell 0.6 percent so far in July, Russia's ruble slid 0.9 percent and India's rupee gained 0.4 percent.

Forwards traders are betting the yuan's gains against the US dollar will be the slowest in a year amid speculation China will resist calls for a stronger currency on concern it will make the country's exports less competitive.

Six-month non-deliverable forwards for the yuan were at 6.4305 on last Friday afternoon, a 0.5 percent premium to the onshore spot rate, based on data compiled by Bloomberg. The gap has averaged 0.5 percent in July, the least since July 2010. The premium has narrowed from this year's high of 1.5 percent in April as Europe's debt crisis bolstered demand for the greenback.

"The current NDF pricing underestimates the pace of future renminbi gains," said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York. "We expect the current bout of global market volatility to remain relatively contained."

Forwards are agreements to buy and sell assets at current prices for delivery at a future specified time and date. Non-deliverable contracts are settled in US dollars.

The yuan was 0.2 percent stronger at 6.4576 per US dollar on Thursday, after Moody's Investors Service put the US credit rating on review for possible downgrade and the Federal Reserve said it may buy more US debt to support an economic recovery. Such purchases, a policy known as quantitative easing, boost the supply of US dollars that can be invested in higher-yielding assets elsewhere. Six-month yuan forwards gained 0.1 percent.

Investors should bet on yuan gains using forwards maturing in six to nine months as the Fed is likely to maintain a "very accommodative monetary policy," Bennenbroek said. "We also believe that further monetary tightening spells further capital inflows and currency gains."

Top priority

The People's Bank of China raised its benchmark interest rates three times this year and lenders' reserve-requirement ratios on six occasions to help tame inflation. One-year government bonds yielded 3.58 percent in China on Thursday, 0.14 percent in the US and 0.13 percent in Japan.

Premier Wen Jiabao said on July 11 that stabilizing inflation remains the top priority for the government after consumer prices increased 6.4 percent from a year earlier in June, the most in three years.

China's economy expanded 9.5 percent from a year earlier in the second quarter, beating the median 9.3 percent growth forecast by analysts in a Bloomberg survey, government data showed last week. The country's foreign-exchange reserves increased US$153 billion to a record US$3.2 trillion, boosted by a trade surplus and capital inflows.

Second-half advance

Yuan gains of 3 percent to 5 percent this year would be appropriate, Yu Bin, director of the macroeconomic research department of the State Council's Development Research Center, said on Thursday at a briefing in Beijing. The exchange rate should be kept flexible to some extent, the China Securities Journal reported on July 11, citing central bank adviser Xia Bin.

"Strong capital inflows, inflation concerns as well as robust economic growth will allow yuan gains to accelerate further in the second half," said Zhou Hao, an economist in Shanghai at Australia & New Zealand Banking Group Ltd, which had the third most-accurate forecasts for the currency. He recommends buying the yuan using three- and six-month forwards, predicting a second-half advance of at least 2.6 percent.

China should continue moving "over time" toward an exchange-rate system that reflects market forces, US Treasury Secretary Timothy F. Geithner said on June 28. He said in May it would help global economies if the "substantially undervalued" currency was allowed to appreciate more rapidly.

The yuan has strengthened 5.6 percent since a two-year US dollar peg ended on June 19 last year. The JPMorgan Nominal Effective Exchange Rate, a trade-weighted index for the yuan, fell 4.1 percent in the same period. The euro and yen strengthened 8.4 percent against China's currency in that time, while Brazil's currency, the real, gained 6.9 percent.

"China hasn't suffered much in terms of competitive loss as a result of the moves that we've seen so far," said Robert Minikin, a senior currency strategist at Standard Chartered Plc in Hong Kong. Inflation and "geopolitical" concerns are likely to prompt policy makers to allow a faster pace of yuan appreciation, he said, predicting a year-end exchange rate of 6.28 per US dollar.

Five-year credit-default swap contracts on China's bonds rose two basis points to 91 basis points on Thursday, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. The contracts insure debt against non-payment, and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.