China devaluation heralds currency war; Greece gets deal

LONDON (Reuters) - China's surprise 2 percent devaluation of the yuan on Tuesday pushed the dollar higher and raised the prospect of a new round of currency wars, just as Greece reached a new deal to contain its debt crisis.

Stocks fell in Asia and Europe as investors worried about the implications of the move to support China's slowing economy and exports.

The stronger dollar hit commodity prices, driving crude oil down after Monday's hefty gains.

Weaker stocks lifted top-rated bonds, with yields on euro zone debt also driven lower by the Greek deal, nine days before Athens is due to repay 3.2 billion euros to the European Central Bank.

China's move, which the central bank described as a "one-off depreciation" based on a new way of managing the exchange rate that better reflected market forces, pushed the yuan to its lowest against the dollar in almost three years.

The Australian dollar , often used as a liquid proxy for the yuan, fell 0.9 percent to $0.7346 as the U.S. dollar rose 0.4 percent against a basket of currencies <.DXY> before paring gains.

In Asia, the Singapore dollar hit a five-year low while the Malaysian ringgit and the Indonesian rupiah hit lows not seen since the Asian financial crisis 17 years ago. The Japanese yen hit a two-month low of 125.08 to the U.S. dollar.

The euro , buoyed by the Greece deal, rose 0.2 percent to $1.1040.

"Devaluation of the yuan likely won't end here. Currencies like the Singapore dollar, South Korean won and Taiwan dollar which stand to compete with China, are falling and today's move could generate headlines heralding the start of a devaluation war," said Masafumi Yamamoto, senior strategist at Monex in Tokyo.

U.S. reaction will be crucial. Washington has for years pressed Beijing to free up the exchange rate to allow the yuan to strengthen, reflecting growth in the world's second-largest economy.

Today, China's economy is slowing and the new exchange rate mechanism gives markets greater ability to push the yuan lower, just as the United States prepares to raise interest rates - a step that should add to dollar strength.

European shares fell. The pan-European FTSEurofirst 300 index <.FTEU3> was down 0.5 percent, led lower by car makers and luxury goods companies, whose products just got more expensive for Chinese consumers. Shares in Athens <.ATG> rose 1.6 percent.

This followed falls in Asia. MSCI's broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> gave up early gains and was last down 1.2 percent at its lowest since February 2014. Japan's Nikkei <.N225> slipped 0.4 percent.

On Chinese stock markets, airlines and importers fell, though exporters rose. The CSI300 index <.CSI300> of the largest listed companies in Shanghai and Shenzhen lost 0.4 percent and the Shanghai Composite <.SSEC> closed flat.

BONDS

Weak stocks boosted top-rated bonds. Germany's benchmark fell 2.7 basis points to 0.68 percent and U.S. 10-year yields dropped more than 4 basis points to 2.19 percent.

The deal on a third bailout for Greece also helped yields on lower-rated Spanish and Italian bonds drop 3 bps apiece while Greek two-year yields fell 4 percentage points to 15.25 percent.

"The Chinese devaluation was taken as 'things are not going that well in China' and this is a risk-off move," said Martin van Vliet, senior rate strategist at ING, adding that "with the Greek deal secured and the ECB continuously buying bonds, peripheral spreads would have been much tighter otherwise."

Oil prices fell as the dollar strengthened. Brent crude was last down 32 cents a barrel at $50.09.

Gold fell as low as $1,093.25 before recovering to $1,114.56.

(Editing by Ruth Pitchford)

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