By Saumya Vaishampayan, Lingling Wei and Gregor Stuart Hunter

HONG KONG--China's yuan surged to its highest level against the dollar since mid-November in offshore markets, sending investors who had bet against it running for cover and boosting Beijing in its battle to defend the currency.

In Hong Kong, where it trades freely, the yuan strengthened 0.6% to 6.8264 to the U.S. dollar, according to Thomson Reuters, its second consecutive day of sharp gains. Within mainland China, where the People's Bank of China limits yuan movement to 2% above or below a level it sets daily, the yuan rose 1% to close at 6.8817 to the dollar, its strongest since Dec. 8.

The gain was part of a broad rise in Asian currencies against the dollar that began overnight, as traders pared back U.S. interest-rate expectations following the release of minutes of the Federal Reserve's December meeting. The Japanese yen and Korean won both gained about 0.6% against the dollar.

Tuesday the dollar had risen as high as 6.9872 yuan in the offshore market, fueling worries that the river of money heading out of China in recent weeks could turn into a torrent.

The reversal came as the cost of borrowing the yuan in Hong Kong surged, squeezing investors out of bets that the currency would decline.

Over the past year, China's central bank has periodically sought to prop up the yuan in the Hong Kong market by instructing Chinese banks in the city to withhold funds; the resulting liquidity shortage raises the cost of wagering against the currency. Traders and analysts say yuan liquidity in Hong Kong became tighter again in the past couple of days."The tightened policies are aimed at defeating those hoping to pile on bets against the renminbi," said a government adviser, using another name for the yuan.

Chinese authorities have upped their efforts to stem the outflow of yuan in recent weeks with measures that include controls on outbound investments by Chinese companies and tighter rules on Chinese residents' converting yuan into foreign currencies.

The result has been fewer yuan in Hong Kong and a higher overnight yuan borrowing rate: Above 10% since Dec. 30, it soared to 38.3% Thursday from 16.95% Wednesday, the highest since a record 66.8% last Jan. 12.

This week China's central bank has also been setting the yuan's official daily "fix" against the dollar at stronger-than-expected levels.

To bet on a drop in the yuan, investors often "short" the currency--borrowing yuan in Hong Kong, swapping them for dollars and later swapping them back at a more-favorable rate. As the cost of borrowing yuan rises, so does the cost of that trade. That can force investors to exit by buying back yuan in Hong Kong, driving the currency higher.

"It's quite expensive to go short the renminbi," said Colin Harte, a multiasset portfolio manager at BNP Paribas Investment Partners in London.

By midmorning Thursday, banks in Hong Kong had fully tapped a 10 billion yuan pool of intraday funding provided by the Hong Kong Monetary Authority, the city's de facto central bank. Two other yuan-funding pools were also heavily used--"reasonable given the tight market liquidity," a monetary authority spokesman said, adding that authorities would continue to closely monitor the offshore yuan market.

Traders have meanwhile sharply reined in their yuan-depreciation expectations for 2017. Currency forwards imply offshore yuan at 7.1470 to the dollar in a year's time, compared with 7.3343 Monday.

Analysts say Beijing still faces a struggle to arrest the yuan's descent. Businesses and individuals concerned about domestic asset bubbles and the uncertain outlook for China's economy are looking for returns outside the country--including in the U.S., where the likelihood of higher interest rates makes assets more attractive.

It is "too early to turn constructive" on the yuan, analysts at Goldman Sachs said in a research note Thursday, saying that the market outlook for China has deteriorated further from a year ago. Its outlook for the end of 2017: 7.3 yuan to the dollar.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com, Lingling Wei at lingling.wei@wsj.com and Gregor Stuart Hunter at gregor.hunter@wsj.com

(END) Dow Jones Newswires

January 05, 2017 07:26 ET (12:26 GMT)

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