Allowing the yuan to weaken, as a local newspaper suggested at the weekend, would mark a significant break with China's policy in the past year of keeping the currency pinned near 8.3 to the dollar, despite devaluations across the region.

Such a breach in Asia's firewall risks triggering a fresh round of competitive devaluations around the region and would put enormous, if not unresistable, pressure on the Hong Kong dollar's peg with the US dollar, traders said.

Against this backdrop, they expect a flight out of yen and emerging market currencies into the dollar, into the traditional safe haven of the Swiss franc, and even into the infant euro.

"I do not think the yuan is going to devalue in the next 12 months but if the worst case did happen, we would see dollar/yen move sharply higher, with 120 only a first stop," said Adrian Cunningham, head ofeconomics at Scottish Mutual Assurance in Glasgow.

"Japan would be hard hit given how heavily it is relying on exports and this would increase pressure for a domestic policy response. Given a monetary policy response is the most obvious, it would be negative for the yen even into the medium term."

A report released overnight showed nearly 40 per cent of Japanese exports were sold to other Asian countries in December 1998.

Such close trade ties mean a yuan devaluation, which sparks weakness in other regional currencies, would put the yen under the sort of pressure seen in 1998 when other Asian currencies were spiralling lower and eroding Japanese competitiveness.

The yen slumped as much as 17 per cent against the dollar in the first eight months of 1998 to hit eight-year lows in the wake of massive markdowns in the value of currencies like the Malaysian ringgit, the Thai baht and the Indonesian rupiah.

That said, traders expect the dollar's allure as a safe haven from Asian turmoil to be temperedthis time around by concern about how Latin America, a key trading region for the US, will be affected by a flight out of emerging markets.

"We will probably see the yen and other Asian currencies under downward pressure against the dollar but if China goes, the pressure will be back on South American currencies and that means the dollar will be affected," said Juergen Lindemann, senior trader at IBJ in London.

"In this case, the euro could end up a little stronger."

Another factor seen hindering a dollar/yen rally is the flow of Japanese capital expected to return home to take advantage of rising domestic government bond yields.

"We will see a spike higher in dollar/yen if the yuan is devalued but I don't expect to see it at 130 or 140," said Martin de Blocq, sales manager at Nomura Bank in London.

"The yield curve is going up, so spreads are not interesting enough for Japanese investors to shift money abroad, and also European investors are underweight Japan, so my underlying feeling is that thiswould probably be a temporary phenomenon."