China central bank taps on brakes as money supply surges

By Zhou Xin and Simon Rabinovitch

BEIJING (Reuters) - China's currency reserves surged past the $2 trillion mark in June and bank lending hit a record high as the central bank showed concern that the flood of cash is pumping up asset prices and could sow the seeds of inflation.

China is not tightening monetary policy aggressively. Analysts rule out interest rate rises this year as the government and central bank agree on the political imperative to ensure a rock-solid recovery in the world's third-largest economy.

But they said the People's Bank of China was clearly indicating that the phase of monetary loosening was over and that it wanted bank lending, which has helped fuel a sharp rise in property and stock prices, to grow more moderately.

"China has achieved impressive results in reviving economic activities," said Gao Shanwen, chief economist with Essence Securities. "The basic tone of the appropriately loose monetary policy is unlikely to change, but there will be fine-tuning."

Gross domestic product figures due on Thursday are likely to show that the economy grew 7.5 percent in the second quarter from a year earlier, confirming China as the first major economy to pull out of a deep dive caused by the global credit crunch.

Yu Song and Helen Qiao, economists at Goldman Sachs, are forecasting 7.8 percent growth. Expressed at an annualized pace after smoothing out seasonal variations, that would equate to a 16 percent growth rate compared with the first quarter.

"We think a gradual policy tightening in an early stage would be a positive move, especially in light of the expected very strong GDP growth in the second quarter and rapidly dissipating deflationary pressures," they said in a note to clients.

TOO MUCH CASH

The central bank reported that its foreign exchange reserves leapt by $177.9 billion in the second quarter to $2.13 trillion.

China is the only country to have amassed over $2 trillion in currency reserves. Its stockpile is twice the size of Japan's, the second-biggest holder, even though its economy is smaller.

As the PBOC buys most of the dollars entering China in order to prevent the exchange rate from appreciating, it issues yuan in exchange. This gives banks additional funds to lend on top of domestically created money.

"The double-pronged liquidity injection is raising risks of future tightening," said Ken Peng, Citi's economist in Beijing.

The broad M2 measure of money supply grew at a record pace of 28.5 percent in June, blowing past forecasts of a 26 percent rise and up from a 25.7 percent increase in May.

Yuan loans outstanding were 34.4 percent higher than a year earlier, also the highest on record, up from May's reading of 30.6 percent.

Soon after the PBOC announced the credit data, traders said it informed a clutch of banks that they would be required to buy 100 billion yuan ($15 billion) in special bills in September -- money that they could otherwise have loaned out.