The New Taiwan (NT) dollar strengthened to more than a one-month high on speculation the central bank will purchase the currency to curb declines.
A slide in the NT dollar last week to a 17-month low increased the cost of imports, adding to inflation.
A weaker currency could also encourage some investors to take funds out of the local markets as the value of their securities is eroded. The NT dollar was the third-worst performer after the Japanese yen among the world's 16 most-actively traded currencies.
"There is still a strong likelihood the central bank will step in," said Tetsuo Yoshikoshi, a market analyst at the treasury unit of Sumitomo Mitsui Banking Corp in Singapore. "One of their concerns is future inflation and another is the outflow of funds."
"If the currency is too weak relative to other regionals, they may lose credibility," he said.
The NT dollar gained for a third day, rising 0.3 percent to NT$33.148 against the US currency at 4pm, the strongest close since April 20, Taipei Forex Inc said.
Turnover was US$1.085 billion.
The currency will probably trade between NT$33.10 and NT$33.30 this week, Yoshikoshi said.
The Taiwanese currency has dropped 1.7 percent this year as the nation's benchmark interest rate of 2.875 percent is among the lowest in the region.
Taiwan's 10-year government bonds rose, ending six days of losses, after traders closed out short positions to realize profits.
The interest rate on borrowing the benchmark debt for one day surged to an annual 19.5 percent, GRETAI Securities Market (櫃櫃買賣中心) said.
That compared with 8 percent early in the morning, Ernest Lee of Mega Securities Co (兆豐證券) said. A short position is where an investor sells borrowed securities, looking to buy them back at a profit after prices fall.
"Some traders bought back debt because it became too expensive to carry short positions," said Lee, a Taipei-based bond trader at Mega Securities, a unit of the nation's second-biggest financial company. "People with short positions were nervous that the cost of borrowing debt had surged too much."
The yield on the benchmark 1 7/8 percent bond maturing March 2017 declined 1.2 basis points to 2.172 percent, said the GRETAI Securities Market, the nation's biggest bond exchange.
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