China raises bank reserves to record in inflation fight

BEIJING Fri Feb 18, 2011 3:31pm EST

Chinese 100 yuan banknotes are seen in this picture illustration taken in Shanghai, January 17 , 2011. REUTERS/Carlos Barria

Chinese 100 yuan banknotes are seen in this picture illustration taken in Shanghai, January 17 , 2011.

Credit: Reuters/Carlos Barria

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BEIJING (Reuters) - China on Friday raised required reserves to a record 19.5 percent, adding to an increasingly aggressive effort by Beijing to stamp out stubbornly high inflation.

The fifth increase since October, all in increments of 50 basis points, will force the country's lenders to lock up a bigger chunk of their deposits at the central bank from next week, removing cash from the fast-growing economy that otherwise would be pushing prices higher.

The move by the People's Bank of China followed an acceleration in inflation to 4.9 percent in the year to January, which was accompanied by worrying signs that price pressures were spreading beyond food to property and consumer goods.

Over the past four months, China has also raised interest rates three times and ordered banks to issue fewer loans in an attempt to make sure it can meet a 2011 inflation target of 4 percent.

By themselves, the individual tightening steps have been small, but taken together they amount to an increasingly intensive effort by Beijing to rein in inflation, which has been a source of political unrest throughout Chinese history.

China is not alone. Central banks across emerging markets have tightened monetary policy during the past year as they rebounded from the global financial crisis much faster than the developed world.

Both India and Brazil raised policy rates in January to quell inflationary pressures.

"China has been moving pretty swiftly in monetary tightening this year," said Zhu Song, a senior trader at Bank of Communications in Beijing.

Sensitive to demand from a country that helped lift the world economy out of the global crisis, copper dipped, oil lost ground and the currencies of commodity exporters such as Australia weakened.

"We think there is more to come in terms of reserve requirements and higher rates and a more rapid appreciation of the currency than the market is discounting," said Adam Cole, global head of currency strategy at RBC Capital Markets.

Soaring food costs have driven Chinese inflation, rising 10.3 percent in the year to January and accounting for nearly three-quarters of the jump in overall prices.

But pressures have been broadening. Non-food inflation, long subdued, rose at its fastest pace in more than a decade in January. And property prices have also been picking up steam again, despite a battery of measures by the government to cool the real estate market.

NO SURPRISE

The latest decision to raise required reserves was, in fact, widely expected by investors in China because a raft of central bank bills will soon be maturing, adding more liquidity to an economy already awash in cash.

"The central bank has to raise banks' reserve requirements to mop up liquidity," said Wang Hu, economist at Guotai Junan Securities in Shanghai.

"It's possible for the central bank to raise required reserve ratios further, but the room is becoming limited," he added.

Despite the lack of a surprise factor, traders said the impact of the higher reserves on Chinese markets would be big, potentially putting an end to a recent run up in equities, setting a floor on money market rates and boosting sentiment toward the yuan.

Excess cash in the economy, stemming from China's trade surplus, is a root cause of fast-rising prices, prompting the central bank to use reserve requirements to lock up a bigger share of deposits and thereby slow money growth.

Along with about 1 trillion yuan in central bank bills that are maturing in February and March, there is also a vast amount of cash that was withdrawn before the Chinese New Year earlier this month that will soon be returning to banks, analysts said.

MORE TIGHTENING AHEAD

In a short statement posted on its website, the People's Bank of China said the increase would be effective from February 24.

The rise will officially take the level for the country's biggest lenders to a record 19.5 percent. The ratio will be somewhat lower for smaller banks.

Anti-inflation talk from the central bank in recent months has primed investors for more policy tightening and, even with the latest move, many believe more is to come and is likely to be front-loaded.

Economists polled by Reuters expect the central bank to raised benchmark interest rates twice more in the first half of this year, before keeping them steady in the second half.

"Currently, China's economic growth is strong and inflation pressures are big. It's necessary to continue to manage liquidity," said Lu Zhengwei, economist at Industrial Bank in Shanghai.

"I believe a price must be paid to bring down inflation. Some industries may suffer as a result of the tightening but it won't hurt the broad economy."

A poll conducted by Reuters in January showed that economist expected growth this year to slow to 9.3 percent from 10.3 percent in 2010, a pace many had feared was unsustainable.

(Additional reporting by Aileen Wang; Writing by Simon Rabinovitch; Editing by Neil Fullick)

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Comments (4)
What’s the impact of this move?

Feb 18, 2011 6:40am EST  --  Report as abuse
yrbmer wrote:
If China would just release the pegs on its currency, it’s inflation problems would be over instantly, and most of that inflation would be exported to the US.

Feb 18, 2011 7:58am EST  --  Report as abuse
jrj90620 wrote:
The U.S. is seeing higher inflation and it doesn’t matter whether China allows it’s currency to appreciate or not.Everything made in China is being priced higher because of high inflation in China.If they revalue the Yuan then inflation would be lower in China but the Dollar would buy less.Either way,the U.S. is going to be paying more for everything.What Bernanke is doing, by devaluing the Dollar to reduce unemployment, is going to cost all of us in higher prices paid.In effect, he is socializing unemployment.Makes sense.We are a socialist country.

Feb 18, 2011 12:17pm EST  --  Report as abuse
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