China and Japan started direct currency trading on Friday as Beijing marked another stage on its journey to foster the yuan's use internationally in line with its growing economic clout.
Market participants can now swap Japanese yen for Chinese yuan without having to use the US dollar as an intermediary currency, making foreign trade settlement more convenient and cutting transaction costs.
The move comes as China, the world's second-largest economy just ahead of Japan, gradually moves to make the yuan freely convertible with an eye towards rivalling the mighty dollar, analysts said.
China maintains a tight grip on its currency, which is not convertible on the capital account, over fears that speculative flows could hurt its economy. That policy has long fostered trade tensions with the United States.
"Yuan-yen direct trading is just a small step toward making the yuan a reserve currency, but what's foremost is whether China can carry out future reforms," Zhang Zhiwei, chief China economist of Nomura Securities, told AFP.
"The move may be another step toward free convertibility of the currency, but from a long-term perspective, China has a long way to go," he said.
On China's national foreign exchange market, the yuan weakened against the yen on the first day of trading under the new practice, due to the Japanese currency's overnight gains against the dollar, dealers said.
"Trading has been active this morning and demand for yen is mostly from China-based Japanese companies," a dealer at a foreign bank in Shanghai told Dow Jones Newswires.
At midday, the yuan was bid at 8.1155 yuan to 100 yen, weakening from the open of 8.1074, according to the Shanghai-based China Foreign Exchange Trade System, the market operator.
British banking giant HSBC, one of the newly appointed market makers in China, said the launch of direct trading will help build a benchmark for non-dollar transactions.
"It is also a significant step forward in the internationalisation of China's currency, supporting the growing demand for yuan payment and settlement globally," David Liao, managing director of global markets for HSBC China, said in a statement.
The Chinese currency will be allowed to fluctuate within a 3.0 percent band above or below a daily mid-point, according to media reports. China has not publicly announced the trading band.
Earlier on Friday, China set that central parity rate at 8.0686 yuan to 100 yen, weakening from 8.0293 on Thursday.
But for the first time, China determined the rate based on an average directly from market makers, instead of using the US dollar as a base, the market operator said in a statement before trading began.
Just last month, China made another move towards liberalisation, allowing the yuan to trade against the dollar in a wider 1.0 percent band on both sides of the mid-point, double the previous 0.5 percent.
China's tightly controlled forex regime is a long-running source of friction with the United States, which accuses Beijing of artificially undervaluing the yuan to boost exports, and which wants more flexibility.
The yuan trades freely offshore, so China's trading-band restriction will not apply in dealings on Tokyo's foreign exchange market.
At midday in Tokyo trade, one yuan stood at 12.28 yen.
Rates in the Chinese and Japanese markets could be different at the outset but are likely to converge very quickly, traders in Tokyo said.
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 forex launch will save about US$3.0 billion in annual costs tied to using the dollar in trade transactions, Chinese state media have reported.