Yuan flirts with 2-1/2-year highs as China's forex reserves expand

SHANGHAI, Feb 9 (Reuters) - China's yuan edged higher on Monday, flirting with the strongest level in more than 2-1/2 years as the dollar weakened after a U.S. Federal Reserve official said there's room to cut interest rates.

Sentiment was also aided by a stronger guidance rate and data showing China's foreign exchange reserves rose more than expected in January.

The yuan had gained for 11 straight weeks in its longest winning streak since early 2013, helped by dollar weakness, China's resilient exports and the growing appeal of China's capital markets.

"Improved sentiment on China's growth outlook, greater policy tolerance for CNY strength, and significant FX undervaluation has reinforced expectations for further CNY appreciation," Goldman Sachs said in a report, using the yuan's official name.

The onshore yuan CNY=CFXS was trading at 6.9335 per dollar at 0242 GMT, a tad stronger than the previous close.

Prior to the market's open on Monday, the People's Bank of China set the midpoint rate CNY=PBOC - around which the yuan is allowed to trade in a 2% band - at 6.9523 per dollar, the strongest since May 16, 2023.

The dollar index .DXY dipped 0.1% in Asian trade on Monday, following Friday's 0.3% drop, as a two-week rebound loses steam.

San Francisco Federal Reserve President Mary Daly said on Friday she thinks one or two more interest rate cuts may be needed to counteract weakness in the U.S. labour market. Lower rates could reduce the greenback's appeal.

Traders were also encouraged by official data showing China's foreign exchange reserves, the world's largest, rose to $3.399 trillion last month, exceeding the $3.372 trillion forecast in a Reuters poll.

Goldman expects the yuan to appreciate gradually, strengthening to 6.7 per dollar in 12 months.

"The macro impact of currency strength is likely moderating over time," the Wall Street bank said, citing China's shift toward higher-tech and higher value-added exports, and Chinese exporters' embrace of forex hedging tools.