The currency rose to a 2 1/2-year high against the dollar Tuesday after the State Bank of Vietnam expanded the currency’s daily trading band to 1 percent Monday from 0.75 percent.

The decision came after the government asked the central bank to allow the dong to strengthen to contain accelerating inflation.

“Band widening is a precursor for the SBV to allow for greater appreciation as it tightens monetary policy,’’ Stewart Newnham, a Hong Kong-based currency strategist at the second-largest US securities firm, wrote in a research note Tuesday.

The Vietnamese dong may advance to 15,000 by the end of this year, Newnham said in an e-mail to Bloomberg, a level unseen since September 2001.

The dong traded at the strongest against the dollar since August 19, 2005.

The currency was little changed at 15,862 per dollar Wednesday, according to prices compiled by Bloomberg.

The government told the State Bank of Vietnam to widen the band to 2 percent, according to a directive posted on the cabinet’s website on March 4.

The central bank sets a daily reference rate for the dong and allows the currency to trade a fixed amount on either side.

Vietnam has had a policy of keeping the dong weak to make exports competitive.

‘Redirecting policy’

“The SBV is in the midst of redirecting policy from targeting the exchange rate to fighting inflation,’’ Newnham wrote.

“Re-establishing price stability has superseded maintaining export competitiveness as the chief policy goal for the authorities.”

Inflation quickened to 15.7 percent in February from a year earlier, the fastest pace since 1995, the government said last month.

A stronger local currency may help reduce the cost of imported dairy products, cooking oils, and petroleum goods.

IMF calls for higher rates

The dong was the third-best performer among Asia’s 17 most-traded currencies versus the dollar in the past five days as the International Monetary Fund (IMF) said Vietnam’s economy was showing signs of overheating and higher borrowing costs were probably needed to slow inflation.

“The signs of overheating in the domestic economy are a concern,’’ said Benedict Bingham, the IMF’s senior resident representative in Hanoi, in a statement Tuesday.

“A sustained period of tighter monetary conditions will likely be necessary to rein in high credit growth.’’

Vietnam’s gross domestic product (GDP) last year expanded 8.5 percent, the fastest since 1996, and the government is targeting growth of 9 percent this year.

Inflation is at the quickest in more than a decade, and the trade gap more than tripled in the first two months of the year, driven by a surge in imports.

The central bank in January raised interest rates for the first time in more than two years and increased compulsory bank reserves to slow inflation.

It will also sell VND20.3 trillion (US$1.3 billion) in bills on March 17 that banks have to buy to reduce money supply.

The dong gained the most in four months Wednesday, the first day the new band was in effect.

“This move is welcome,’’ Bingham said.

A tightening of monetary policy is necessary because of Vietnam’s credit growth of “around 50 percent” in 2007, he said.

Money-market disruptions Vietnam is facing a choice between “high growth in the short run versus financial stability,” Ho Chi Minh City-based fund manager Vinacapital Investment Management Ltd. said in a report last month.

State Bank of Vietnam Governor Nguyen Van Giau on January 30 raised the base rate to 8.75 percent from 8.25 percent, refinancing rate to 7.5 percent from 6.5 percent, and discount rate to 6 percent from 4.5 percent.

“The decision of the State Bank of Vietnam to tighten monetary policy at the start of the year was appropriate given the rise in inflation and widening of the trade deficit,’’ Bingham said in the report.

Vietnam would “minimize disruptions to the domestic money market,” through “controlled increases in interest rates’’ rather than trying to control the supply of cash in the economy, the statement said.

Source: Bloomberg