China fuel hike to boost stock index, yields

By Karen Yeung and Lu Jianxin - Analysis

SHANGHAI (Reuters) - China's hike in domestic fuel and electricity prices is set to boost stock indexes as shares in oil refiners and power generators rise, while it will put upward pressure on long-term bond yields, analysts said on Friday.

The immediate market impact of the hike, announced late on Thursday, is expected to be small because investors had already been speculating about it for a couple of weeks.

Shares in the company which may benefit most, oil refining giant Sinopec (600028.SS), are up 11.6 percent so far this week, while the Shanghai Composite Index .SSEC has dropped 4.2 percent to a 16-month low.

One of the stocks most vulnerable to higher fuel prices, flag carrier Air China (601111.SS), is already down 18.0 percent this week, which may leave little room for further falls.

But many investors had been expecting the government to delay the fuel price hike until after the Beijing Olympics in August, so shares such as Sinopec, fellow refiner PetroChina (601857.SS) and power generator Huaneng Power (600011.SS) may climb a few percent on Friday, analysts said.

Sinopec and PetroChina alone account for about 20 percent of listed Chinese companies' earnings, so a further rise in their shares could help the stock index rise 1 or 2 percent, the analysts estimated.

"This will boost the stock market for a short while as struggling refineries and power companies, which have a big weight in the index, are expected to jump," said Ren Chengde, senior equities analyst at Galaxy Securities in Shanghai.

"But in the medium and long term, the hike is a big negative factor for the overall market because it is a signal that the government has given up on its previous target of keeping inflation at 4.8 percent for all of 2008.

"From now on, whenever food prices fall and give the government room to adjust other prices, investors must expect hikes in prices of major commodities. This is hugely negative news for downstream industries such as airlines, metals, and other major energy and commodity consumers."

YIELDS UNDER UPWARD PRESSURE

Money market liquidity is fairly good, which should prevent a significant rise in bill and short-term bond yields. But longer-term bond yields are likely to climb because the fuel price hike will limit a hoped-for drop of consumer price inflation in the second half of 2008, analysts said.

"Bond yields, which stabilized and even fell in recent days, will resume rising as the energy price hike puts upward pressure in on inflation," said Shi Lei, analyst at Bank of China.

He calculated higher fuel prices would add 0.5 percentage point to inflation, so that June inflation would fall to about 7.5 percent instead of 7.0 percent, from May's 7.7 percent.

"The bond curve will steepen today with long-term bond yields rising about 5 basis points today and small rises at the short end," Shi said, adding that the yield at Friday's 10-year bond government auction might now exceed previous market expectations of 4.33 percent.

A trader at a European bank in Shanghai said the central bank might raise bank reserve ratios once again as soon as the start of July, to counter inflationary expectations resulting from the fuel price hike.