China on Saturday said it would gradually make the yuan more flexible, in a gesture that may deflect foreign criticism at next week's G20 summit, but will not quickly yield a big move by its currency.

U.S. President Barack Obama, who prodded China over the yuan in a letter released on Friday ahead of a Group of 20 meeting next week, welcomed the news -- remarks that indicate the danger of a market-roiling G20 confrontation has eased.

China's decision to increase the flexibility of its exchange rate is a constructive step that can help safeguard the recovery and contribute to a more balanced global economy, Obama said in a statement.

Other Western leaders and the International Monetary Fund also voiced encouragement that an important strategic ally was making a concession that improves the chances for a success at the June 26-27 summit.

But the announcement by China's central bank, which strongly suggests it was ready to break the currency's 23-month-old dollar peg, was conditioned by an explicit warning ruling out a one-off revaluation or major yuan appreciation.

The basis for large-scale appreciation of the RMB exchange rate does not exist, the People's Bank of China said.

The yuan is also known as the renminbi, or RMB.

China's dollar peg has come under intense fire from abroad as its 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.

China is blamed for keeping the yuan artificially cheap against the dollar, which has contributed to a massive trade surplus in China with the United States.

TRADE WAR

U.S. patience with Beijing over the yuan has worn particularly thin and lawmakers threaten to penalize it for a strategy they say unfairly hurts American exports.

Democratic U.S. Senator Charles Schumer, a leading critic, said China's statement was too vague and pledged to press ahead with action to raise trade barriers.

U.S. Treasury Secretary Timothy Geithner, who has delayed publication of a potentially embarrassing report that could cite China as a currency manipulator, also stressed that China's actions will speak louder than words.

This is an important step but the test is how far and how fast they let the currency appreciate, he said.

The report, due on April 15, was put on the back-burner until after the G20 to give China time to act.

Obama needs China's help on a range of other delicate issues, including sanctions against Iran and North Korea for their nuclear programs. He must balance quiet diplomacy against an urgent domestic political need to be seen fighting China for U.S. jobs ahead of November midterm congressional elections.

U.S. businesses must also tread softly with China. Caterpillar Inc, the U.S. machinery giant that sells billions of dollars of earthmoving equipment and other products to China each year, said it was heartened by the decision.

G20 leaders have promised to tackle this sort of global imbalance. But Beijing's recent insistence that the summit was the wrong place to talk about yuan flexibility could have overshadowed the meeting and damaged important trust. China has reduced that risk with Saturday's announcement.

This is an important move as it signals recognition by Chinese officials that a more flexible exchange rate is in China's own interest and also acknowledges its responsibility to the international community, said Eswar Prasad, a former head of the IMF's China division.

China has 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 also soothe fears of a trade dispute between the United States and China at a delicate time for the world economy and may 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. This had been defended as a special protection policy during 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.

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.

(Additional reporting by Phil Smith, Lu Jianxin and Zhou Xin, David Lawder, Andy Sullivan, Emily Kaiser and Lesley Wroughton in Washington, James Kelleher in Chicago; Writing by Simon Rabinovitch and Alister Bull; Editing by Neil Fullick, Kristin Roberts and Will Dunham)

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