(Bloomberg) -- The yuan may rally to approach the 7-per-dollar level over the next few weeks as bets that the dollar has peaked and a potential turnaround in the Chinese economy add support, analysts said.

The dollar’s recent retreat and signs of thawing ties between Beijing and Washington have triggered a sharp rebound in the Chinese currency in November after months of weakness. On Tuesday, the People’s Bank of China raised its daily fixing by the most since July, lifting the yuan to a four-month high.    

China’s widening rates differential with the US this year has put the yuan under pressure, as the PBOC cut rates while the Federal Reserve aggressively hikes. With the US seen as nearing the end of its increases, Oversea-Chinese Banking Corp and Grow Investment Group are among those expecting the Chinese currency to strengthen at least 0.6% from here past 7.1. 

The strength may give the PBOC breathing room to consider more aggressive easing steps including a policy rate cut, according to some analysts.  

“To me, it looks like they are doing preparatory work ahead of its policy rate cut,” said Kiyong Seong, lead Asia macro strategist at Societe Generale SA in Hong Kong, referring to the PBOC’s stronger fixing. “When the external environment is favorable, they may strengthen the yuan as much as possible.”

The PBOC cut its one-year policy rate twice in 2023 to aid growth, but the room for further easing has become limited due to worries over currency weakness and capital outflows. Instead, it has focused on liquidity management while using a variety of tools including the daily reference rate to support the yuan.  

READ: China Pauses Rate Cuts as Focus Shifts to Credit Stability (2)

Bullish momentum may drive the currency to strengthen even beyond the psychologically-important 7 level, according to Bloomberg Intelligence’s strategist Stephen Chiu. Seasonal demand for the yuan as exporters sell their dollar holdings may also lend support, he said.   

Dollar’s Retreat  

A rapid unwinding of the dollar’s strength is in the yuan’s favor, as well as for other emerging markets. 

The Bloomberg Dollar Spot Index rose almost 7% between a July low and early October, as traders weighed the possibility of higher-for-longer interest rates in the US. Since then, the gauge has erased about half of that advance as slowing inflation encouraged traders to price in Fed rate cuts next year. 

Both the onshore and offshore yuan strengthened Tuesday past the central bank’s daily reference exchange rate for the first time since July, reaching about 7.13 each. Beijing allows the currency to trade 2% above or below the reference rate in the domestic market. 

Zhou Hao, chief economist at Guotai Junan International, revised his forecast for the yuan upward to a range of 7 to 7.17 per dollar into the year-end. Hao Hong, chief economist at Grow Investment Group, expects it to rally past 7.1 per dollar “very soon” as US yields stabilize and the gap between China and US narrows.

Bullish sentiment is gaining traction in the offshore market, where traders observed long dollar positions unwinding as more players had begun to bet on a stronger yuan. 

Officials have kept a tight grip on the reference rate by keeping the fixing largely unchanged in October. 

“The strategy of buying time to wait for the dollar’s turn paid off once again,” said Christopher Wong, strategist at Oversea-Chinese Banking Corp. The currency could strengthen to 7.08 in the coming weeks, he added. 

--With assistance from Ran Li.

©2023 Bloomberg L.P.