Wells Fargo & Co said that the Chinese Yuan may appreciate by as much as 7% over the next 18 months and that current Yuan forwards are underestimating the pace of gains in China’s currency.

China’s central bank may allow the Yuan to resume appreciation by the middle of 2011 and then seek a 6-8% appreciation against the dollar, said Nick Bennenbroek, Wells Fargo’s head of currency strategy, in a research note dated on Wednesday.

Wells Fargo says that companies should buy the non-deliverable forward to hedge against strengthening the currency.

Allowing the Chinese Yuan to appreciate may help the country keep its inflation rate under control amidst record breaking growth in lending and real estate prices. The exchange rate has remained at about 6.83 Yuan to U.S. dollar since July of 2008 as policy makers have intervened to keep the country’s exports high during the financial crisis.

Bennenbroek wrote,  “Whether the renminbi appreciation begins in April, May or June, we expect currency gains over the next year to outpace the move currently priced into the non-deliverable forward market.”

The 12-month non-deliverable forward rose 0.1% to 6.60 Yuan in Shanghai by the end of the trading day, reflecting that traders predict the Yuan will appreciate 2.5% from the spot rate of 6.827. Bennenbroek is predicting an appreciation rate of 3.5%

China is currently carrying out stress test on its labor-intensive industries to gage the potential impact of a strong Yuan on earnings, according to a new report from the 21st Century Business Herald reported today, citing unidentified officials.

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