China raises bank reserves again to tame inflation

BEIJING Thu May 12, 2011 9:28am EDT

Chinese one yuan coins and 100 yuan banknotes are seen in this picture illustration taken in Beijing, December 30, 2010. REUTERS/Petar Kujundzic

Chinese one yuan coins and 100 yuan banknotes are seen in this picture illustration taken in Beijing, December 30, 2010.

Credit: Reuters/Petar Kujundzic

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BEIJING (Reuters) - China lifted bank reserve requirements by 50 basis points on Thursday, signaling that containing inflation and soaking up excess cash remained its top priority even after signs the economy was slowing down.

The announcement of more tightening came as a surprise to some analysts who had expected the People's Bank of China to tap the monetary brakes more gently after a host of data from industrial output to imports were weaker than expected in April.

To many of them, China's latest directive to lock up more of the deposits that banks would otherwise have lent was simply an attempt to drain inflationary capital inflows rather than opt for a rate rise, ostensibly a heavier monetary tool.

"The central bank is moving the deposit reserve ratio again to soak up liquidity as hot money inflows and current account surplus remain large," said Xu Biao, an economist with China Merchants Bank in Shenzhen.

"It should not be read as a real tightening move. Instead, it may have become part of China's neutral monetary policy operations. If that's the case, the central bank will continue to raise the ratio."

The increase in bank reserves came a day after data showed China's factory output growth in April eased much more than expected, while annual increases in money supply and outstanding yuan loans hit their lowest pace in 29 months --signs that measures to slow the economy are starting to bite.

Any signs the world's second-largest economy is slowing rather sharply or that the authorities have misjudged the policy balance between sustaining growth and capping prices could unnerve markets in energy and commodities.

Jim O'Neill, chairman of Goldman Sachs Asset Management, said on Thursday the Chinese economy might cool more than most people anticipate. Wang Jian, a researcher with the National Development and Reform Commission, China's top economic planner, predicted this week that Beijing would actually cut interest rates in the second half.

Yet consumer price inflation, at 5.3 percent in April, remained above expectations and well above the four percent target the central bank has set for the year.

Food prices fell 0.4 percent in April from March but were 11.5 percent higher than a year earlier. Non-food prices rose 0.4 percent in April from March.

Trade data for April also showed record exports in April and a weak pace of imports led to a wide trade surplus.

Capital inflows, a large trade surplus that is flooding the economy with more cash and pockets of exuberance in the property sector might have the central bank still keeping policy tight, albeit through measures aimed at mopping up cash rather than raising rates across the economy, analysts reckoned.

"As long as capital inflows continues, they will have to raise the RRR. From a macro-perspective, it is not a tightening but a sterilization of liquidity," said Wei Yao, an economist with Societe Generate in Hong Kong.

MORE RISES EXPECTED

The latest bank reserve rise, which came after domestic markets closed, weighed on global oil prices but had little impact on global currency and stock markets.

The reserve rise will take effect from May 18, the central bank said in a terse statement on its website.

The increase, the eighth since October, will raise the reserve requirement ratio to a record 21 percent for China's biggest banks.

The world's fastest-growing economy expanded more than 10 percent last year as it emerged strongly from the global financial crisis

Policymakers, targeting 4 percent average inflation for 2011, have declared inflation-fighting their top priority this year after high food prices raised fears of broader inflation that could destabilize the economy or even spark social unrest.

The central bank sold 40 billion yuan ($6.2 billion) of three-year bills in regular open market operations on Thursday as apart of its efforts to mop up excessive cash in the economy.

"When we look at the inflation and bank lending data and with the PBOC saying that there is no natural upper limit for reserve requirement increase, I don't think this is a big surprise," said Brian Jackson, senior emerging markets strategist at Royal Bank of Canada in Hong Kong .

He expect the central bank to raise interest rates by 25 basis points before June and raise rates by another 25 basis points by the third quarter.

A wall of cash from foreign direct investment, China's gaping trade surplus, and maturing central bank bills and repos, is set to pour into China in coming weeks and months.

Analysts expected China to raise the reserve requirement ratio to 21.5 percent by December, a Reuters poll in April showed.

(Editing by Jacqueline Wong and Vidya Ranganathan)

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