China and Japan to begin direct currency trading

China and Japan will start direct currency trading on Friday as Beijing marks another stage on its journey to internationalise the yuan.

Forex traders will be able to swap Japanese yen for the Chinese unit without having to use the US dollar as an intermediary currency when markets open in Tokyo and Shanghai at 0000 GMT.

The yuan-yen trade -- part of a wider deal reached last year between Beijing and Tokyo to forge closer ties --- will be allowed to move in a wider range than the narrow band at which the dollar and yuan change hands.

China will set a daily rate based on dealer quotes, with trade allowed to move within a 3.0 percent band above or below that rate, compared with a 1.0 percent band fixed to the yuan-dollar.

The trading-band rule applies only in Shanghai while free exchanges are guaranteed in Tokyo.

Rates in the two markets could be different briefly but are likely to converge very quickly, traders said.

It is impossible to make money through price gaps between the two markets, said Akira Hoshino, head of foreign exchange trading at Tokyo-Mitsubishi UFJ Bank.

"Supposing the dollar mid-point price was set at 80 yen and the quotation was at 83 yen in Shanghai and 86 yen in Tokyo, no-one would sell the dollar at 83 yen though many people would want to buy it at that level."

"Such trading would not happen," he said.

The new system paves the way for "full-fledged direct exchange trading," Japan's Finance Minister Jun Azumi said Tuesday.

By not using the dollar as an intermediate currency "we can lower transaction costs and reduce settlement risks at financial institutions as well as making both nations' currencies more useful", he added.

Beijing's tightly controlled foreign exchange policy has triggered huge trade deficits in the United States, which accuses China of artificially undervaluing the yuan to boost exports, and has been a long-running source of friction between the world's two largest economies.

On Tuesday, China said direct yuan-yen trade was an "important step" in "strengthening cooperation between China and Japan in developing financial markets and mutually promoting direct trading between the two currencies based on market principle."

China overtook Japan to become the world's second-largest economy in 2010, and the neighbours are forging closer business ties despite frequent diplomatic spats over territorial claims and lingering historical animosities.

China is Japan's largest trading partner, but about 60 percent of their mutual trade is denominated in US dollars.

The official Xinhua news agency reported that the deal will save about $3.0 billion in annual costs tied to using the dollar in trade transactions.

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