China surprises with further rise in banks’ reserves

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China raised the level of reserves banks must hold for the second time this year on Friday, spooking financial markets on the eve of its New Year holiday by showing it was intent to curb lending and inflation.

Although investors had been expecting the People’s Bank of China to push the reserve requirement ratio higher after an increase last month, few thought the second rise would come so soon.

Markets were rattled by fears that monetary tightening in the world’s third-largest economy would be more aggressive than had been reckoned on, potentially denting global growth.

Investors pulled back from riskier assets, buoying the dollar. Stocks and oil fell, while European and US bonds jumped.

“The central bank is sending clear messages to banks that it wants more reasonable bank lending and it is paying close attention to inflation,” Xie Xuecheng, an economist with Southwest Securities in Beijing, said.

Analysts said the reserve requirement increase should not be construed as serious tightening, because it only goes some distance to mopping up cash injected in the economy before the Chinese New Year, a week-long holiday which begins on Saturday.

But that did not diminish the surprise, particularly since China on Thursday had reported an unexpected slowdown in consumer price inflation in January to 1.5 percent from a year earlier.

The dip in inflation is likely to be temporary because of seasonal factors, but markets had still interpreted it as a sign that the central bank could proceed more gradually with tightening after last year’s ultra-loose pro-growth policies.

Get used to it

This week’s data also showed that, for all the government’s insistence that banks control their pace of lending, Beijing has still been struggling to rein in credit. Banks lent 1.39 trillion yuan (US$203.4 billion) in January, the third-largest monthly total on record.

With the reserve requirement increase, China’s biggest banks will now have to put 16.5 percent of their deposits on hold at the central bank, crimping their ability to lend.

“Even though the inflation threat is mild, the central bank faces huge pressure to mop up excessive funds from commercial banks to reduce their urge to extend corporate loans,” Shi Lei, an analyst at Bank of China in Beijing, said.

“But the hike will still not fundamentally tighten liquidity too much and there will be more reserve ratio hikes,” Shi said.

The 50 basis point rise, which comes into force on February 25 after the New Year’s holiday, will drain about 300 billion yuan.

The Chinese economy remains awash in cash after a record surge of 9.6 trillion yuan in bank lending last year. On top of that, the central bank injected a net 604 billion yuan ($88.6 billion) in open market operations over the past three weeks, and a raft of bills are due to mature in March.

“Liquidity needs to be withdrawn after the holiday somehow. And an RRR hike is the most cost effective way of doing so,” Qing Wang, an economist with Morgan Stanley in Hong Kong, said in a note. “We would like to reiterate this should not be viewed as outright tightening. The market should get used to it.”

More ahead

Economists polled by Reuters expect the central bank to raise benchmark interest rates in the second quarter, following with a second rate rise later in the year.

Ben Simpfendorfer, an economist with Royal Bank of Scotland, said Friday’s move did not change the picture.

“There are no forecast implications. I still expect the policy rate to be hiked late in the second quarter,” he said.

Even more important than interest rate increases in the Chinese economy, Beijing is also expected to step up its so-called window guidance to get banks to slow their lending.

The central bank all but confirmed this week that it would take a raft of tightening steps in the coming months, when it pledged to “normalize” monetary conditions.

That could be a bitter pill for global markets to swallow.

China powered to 8.7 percent growth last year, by far the strongest of any major economy, driving demand for everything from Chilean copper to Australian iron ore.

Worries that China’s tightening might dampen global economic growth were compounded on Friday by weak European data and the struggle to sort out Greece’s debt crisis.

Central bankers outside China are also being forced to grapple with the impact of Beijing’s policy choices. The Reserve Bank of Australia surprised markets last week by skipping an interest rate rise, noting China’s tightening as a factor.

Source: Reuters

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