(Reuters) - China will gradually make the yuan's exchange rate more flexible, the central bank said on Saturday a week before a G20 summit, strongly suggesting that it was ready to break the currency's 23-month-old dollar peg.
However, it all but ruled out a one-off revaluation or major appreciation, saying there was "no basis for big fluctuations or changes" in the exchange rate.
The dollar peg has come under intense fire from abroad as China's export juggernaut roared back to life, while much of the rest of the global economy remained sluggish and beset by unemployment in the wake of the financial crisis.
Just ahead of a G20 summit in Canada, the announcement seemed to be intended to placate critics of China's currency regime. It was welcomed by U.S. Treasury Secretary Timothy Geithner who called for "vigorous implementation" of the change.
But China had long said that it would not bow to international pressure over its currency and the central bank went out of its way to dampen expectations for any big yuan rise.
"We believe this is a positive gesture, suggesting the yuan will soon resume its appreciation against the dollar," Goldman Sachs economists Yu Song and Helen Qiao said.
The news could soothe investor fears of a trade row between the United States and China at a delicate time for the world economy and propel world stocks markets higher on Monday.
It was clear that China intended its announcement -- published in English at around the same time as Chinese, a departure from usual practice -- to mark the end of the yuan's de facto peg to the dollar, which it had defended as a "special policy" to protect its economy from the global financial crisis.
"The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with enhanced economic stability," the Chinese central bank said in a statement on its website.
"It is desirable to proceed further with reform of RMB exchange rate regime and increase the RMB exchange rate flexibility," it said.
The yuan is also known as the renminbi, or RMB.
Dominique Strauss-Kahn, head of the International Monetary Fund, also saluted the announcement, saying it would boost Chinese household incomes and domestic investment, key ingredients for rebalancing the global economy.
RISE -- AND FALL
In practice, it is likely to mean that the central bank will use its system of setting daily reference rates for the yuan to guide the currency back to a path of gradual appreciation against the dollar, which it followed for three years until mid-2008.
Initial movements in the yuan's exchange rate will probably be small, but cumulatively, it could amount to several percentage points of accumulation over the next few months, several analysts.
The "crisis-mode" of locking the yuan to the dollar was over, but any appreciation would likely be slow and modest, said Li Daokui, an academic adviser to the monetary policy committee of the People's Bank of China, the central bank.
In fact, the yuan could begin to move in two directions, he told Reuters.
"If the euro falls sharply against the dollar, the yuan may depreciate against the dollar as it refers to a basket of currencies. But if the euro stabilizes, the yuan could rise against the dollar," he said.
"The message to the outside world is: don't pressure us," he said.
Whether the outside world, especially U.S. lawmakers who say an undervalued currency gives China an unfair trade advantage, will agree with that remains to be seen.
PRESSURE FLARING UP
International complaints about China's exchange rate policy had died down in recent months as the European sovereign debt crisis became the dominant concern, but pressure had just begun to flare up again.
A group of U.S. lawmakers, led by Senator Charles Schumer, were pushing for a bill that would allow the United States to use countervailing duties against countries with "fundamentally misaligned" exchange rates.
And the yuan was threatening to be the elephant in the room at a G20 summit in Canada on June 26 and 27.
U.S. President Barack Obama said that it was essential to global economic vitality that countries adopt market-oriented exchange rates, but a series of Chinese officials said the yuan was China's sovereign concern and should not be discussed in international circles.
China has held the yuan at roughly 6.83 to the dollar since July 2008 in an attempt to insulate the fastest-growing major economy from the global financial turmoil sparked by the U.S. credit crunch.
"The government has made the reform of the exchange rate a priority and has been waiting for the right time to move forward," said Gao Shanwen, chief economist of Essence Securities.
"Now is the best time to carry out the reform," he said, pointing to weak market expectations for appreciation, which could help curb the hot money inflows chasing a stronger yuan that have long been dreaded by the Chinese government.
At the end of trading on Friday, investors were betting on the yuan rising 2.2 percent against the dollar over the next 12 months, according to pricing in offshore forwards.