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China's yuan higher -- dollar gains too

By Blake Ellis, staff reporter

NEW YORK (CNNMoney.com) -- Despite China's decision to let its currency float more freely, the dollar gained Monday as investors recognized China's move would be gradual.

While China emphasized over the weekend that investors should not expect big increases in the value of the yuan, the decision was enough to boost the Chinese currency more than 0.4%, the biggest single-day move since 2005, said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

After falling sharply and then seesawing early Monday, the dollar was up 0.5% against the euro in afternoon trading and rose 0.4% versus the British pound. The greenback jumped 0.3% against the yen.

"While the China news is a positive right now, people are not really sure what to make of it in the long run and maybe investors are wondering if we are exaggerating the significance of this," said Chandler. "So right now, you've got some euphoria and some profit-taking."

Another reason the dollar didn't decline was because investors were largely expecting a currency move from China before the G-20 summit on Saturday, so the bank's announcement didn't come as a huge surprise, said David Leaver, a senior trader at Forex.com.

"The market was positioned for [China's currency move], which limited the follow-through on the downside," said Leaver.

"We've seen the dollar going up lately and the impetus is the global growth story, so today's [strength] is part of that trend," he added.

A more "flexible" yuan: China has kept the value of the yuan pegged to the U.S. dollar since July 2008, and many economists say it is undervalued, giving Chinese companies an unfair advantage over their U.S. counterparts.

Over the weekend, China said it would increase the "flexibility" of its exchange rate in response to the recovering global economy. The bank issued a second statement Sunday emphasizing that the bank is going to remain cautious, reminding investors not to expect huge hikes.

The currency reform would be "gradual," and "the basis for large-scale appreciation does not exist," the bank said in separate statements.

But even if it's a gradual move, China's decision to let its currency trade more freely sends the message that China is confident about the global economic outlook, said Chandler.

Why now?: As China's economy continues to surge, the bank said now is a good time to take further steps to manage growth.

A stronger yuan would help contain inflation in China, and boost consumer's buying power there.

The bank's currency move also comes a week ahead of the G-20 economic summit, where President Obama and other world leaders will meet in Toronto will discuss China's currency policy.

"We welcome China's decision to increase the flexibility of its exchange rate," Treasury Secretary Tim Geithner said Saturday. "Vigorous implementation would make a positive contribution to strong and balanced global growth."

While a stronger yuan -- and a weaker dollar -- is widely considered to be a good thing for U.S. manufacturers, it won't come without some pain for Americans.

China has been keeping the yuan cheap by buying massive amounts of U.S. dollars and Treasurys. If the yuan floated freely, China wouldn't need to buy as much. And that could mean higher interest rates on Treasurys, and thus higher borrowing costs for many U.S. homeowners and businesses.

If it leads to a slide in the value of the dollar, that could raise the price of imports, such as oil.

--CNN Wires contributed to this report. To top of page

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