* Many market players had expected pause on tightening
* Chinese interest rate swaps could correct upwards
* Impact on stocks could be offset if nuclear fears subside
* Yuan could rise further as another inflation-fighting tool
By Lu Jianxin and Jason Subler
SHANGHAI, March 18 (Reuters) - Chinese interest rate swaps, share prices and the yuan are all expected to rise on Monday, though for different reasons, after the central bank unexpectedly raised banks’ reserve requirement ratios (RRR) after markets had closed on Friday.
The 50 basis point increase in the proportion of deposits that banks must hold on reserve with the People’s Bank of China (PBOC), the third such rise this year and the sixth since November, will catch many investors off guard. [ID:nTOE722076]
IRS and money market rates have dropped excessively over the past few weeks on the prospect the PBOC’s monetary tightening might not be as harsh as the market had previously expected, traders said.
Several prominent economists had also predicted this week that the PBOC would take some time to gauge the impact of Japan’s devastating earthquake and tsunami, contributing to expectations further tightening was off the cards for now.
“Few expected a RRR hike to come at this time,” said Liu Junyu, senior debt market analyst at China Merchants Bank in Shenzhen.
“It means the government has by no means relaxed its efforts to curb inflation, no matter what has happened in Japan or whatever the market has guessed.”
The benchmark five-year IRS CNYQB7R5Y=, which plunged 76 basis points over the past month to close at 3.7 percent on Friday, is likely to rebound to a level around 4 percent, where it may build up a floor, traders said. [CN/]
Many had taken the central bank’s actions in its open market operations as another sign it might not raise required reserves or interest rates soon.
The PBOC has drained funds through bill sales and bond repurchase agreements in each of the last two weeks, raising the hope it might be able to manage liquidity without turning to the harsher tool of raising required reserves. [CN/MMT]
However, the central bank could be moving pre-emptively to fend off a large amount of cash that will re-enter the financial system in the next several weeks, or even through inflows of foreign capital that have not yet been reported, analysts said.
Close to 750 billion yuan in PBOC bills are set to mature by the end of April, putting extra pressure on the PBOC to find ways to drain liquidity.
“It appears to be an indication that foreign capital inflows into China remain high, and there are too many maturing central bank bills, which are pumping money into the system,” said Qian Qimin, deputy head of research at Shenyin & Wanguo Securities in Shanghai.
“But the market has gotten used to such RRR hikes, and there should be no big impact on share price movements,” he said.
Any negative impact on the stock market from the increase in required reserves could be offset by the fact mainland shares may have overreacted over the past week to concerns about the nuclear crisis in Japan following last week’s earthquake, analysts said.
The benchmark Shanghai Composite Index .SSEC fell 0.9 percent this week, despite a flurry of record-high quarterly profits reported by many top companies over the last week. [.SS]
Should worries over the nuclear situation subside somewhat, the Chinese market could continue to edge up after rising 0.3 percent on Friday to close at 2,906.9 points, but it will likely face resistance at 3,000 points, traders said.
The signal from the PBOC that it is ready to do whatever it takes to fight inflation could also give a boost to the yuan CNY=CFXS, should the central bank wish to use it too to signal its intent to keep prices from getting out of control.
The PBOC has already allowed the currency to creep upwards this year to around 6.57 to the dollar, up nearly 4 percent since it was de-pegged last summer, in what some analysts say is a sign it is ready to use the currency as part of its anti-inflationary campaign.
More and more Chinese analysts have begun to argue that higher commodity prices warrant a further increase in the yuan’s value, as it would lower the cost of imported raw materials.
Yu Yongding, a former academic adviser to the central bank, said on Friday that China should stop intervening in the currency market to keep the yuan steady because the cost of doing so is ballooning as rising commodity prices erode the value of the dollar and of China’s vast foreign exchange reserves. [ID:nLDE72H17O]
Several dealers said they expect the yuan to hit another few record highs next week, with one possibly on Monday, after it closed near a record high on Friday. [CNY/]