The move between world's second largest economy China and third largest economy Japan will bring the yuan one step closer to becoming a truly global currency, official media here said.
Japan ranks fourth among China's trading partners after the European Union, the US and the Association of Southeast Asian Nations, while China has been Japan's largest trading partner for the past three consecutive years. Bilateral trade rose 14.3 per cent year-on-year to reach USD 344.9 billion last year.
The trading marks the first time for China to allow a major currency other than the US dollar to be traded directly against the Chinese currency RMB, or the yuan.
As part of the efforts between China and Japan to strengthen cooperation in developing the financial market, the move serves as an important means of promoting direct yuan-yen trading, the People's Bank of China said in a statement.
Analysts see this move as a broader strategy by China to reduce dependence on US dollar as well as internationalise its currency. China reportedly chose Japanese Yen because of the large amount of trade between the two countries stretching over USD 400 billion. It also expected to help them to deal with currency uncertainty due to EU debt crisis.
According to the announcement Yuan-yen trading will start on China's inter-bank foreign exchange market on Friday.
The central parity rate of the yuan against the yen will be based on the average price of offers made by registered dealers before the opening of the market each business day, state run Xinhua reported.
With the greenback as an intermediate currency, the yuan is currently allowed to be traded against eight other currencies on the market, including the euro, British pound, Hong Kong dollar, Japanese yen, Malaysian ringgit, Russian ruble, Australian dollar and Canadian dollar.
China and India reached an agreement to permit USD one billion under external commercial borrowing by private sector last year.
The new move is expected to boost trade between China and Japan the two leading economies in the wake of the eurozone's economic downturns, and more importantly, promote greater internationalisation of the yuan, analysts said. "A directly-formed yuan-yen exchange rate will help enterprises mitigate risks brought by a fluctuating US dollar and reduce exchange losses for Chinese and Japanese companies," Ding Zhijie, dean of the School of Banking and Finance with the University of International Business and Economics said.