China stocks, bonds to take hit on PBOC surprise

SHANGHAI (Reuters) - Chinese stock and bond markets will likely take a hit on Wednesday and yuan forwards should price in more appreciation after the country’s central bank hiked the amount of reserves banks must set aside, a move that hurt riskier assets around the world.

The People’s Bank of China hiked banks’ reserve requirement ratio by 0.5 percentage point, the first move since a cut in December 2008 and delivering the clearest sign it is tightening policy as the lending-fuelled economy powers ahead.

* China's benchmark Shanghai Composite Index .SSEC could fall around 2 percent as investors turn nervous about quicker-than-expected exit end to the government's economic stimulus launched in late 2008.

* The stock market has already been under pressure after the PBOC started tightening liquidity in the past week, including a rise in its benchmark one-year bill yields on Tuesday.

* The index closed at 3,273 points on Tuesday and is virtually flat for the year after having surged 80 percent in 2009.

* An official campaign to keep asset prices in check has dogged investors as well. Authorities have approved many initial public offerings, hoping the extra supply would stem the market’s rise, and they have also clamped down on the property market.

* But the Shanghai index has also been supported by market reforms, such as the launch of stock index futures and short selling.

* China’s government bond yield curve is expected to flatten, with short-term bill and bond yields seen jumping about five basis points and outpacing any rise in long-term yields. Ample liquidity in the bond market will partly offset the central bank’s tightening.

* Short-term yields have already soared in the past week after the PBOC lifted rates in two operations, making clear that a change in policy was afoot.

* The benchmark seven-day bond repurchase rate, which has been dropping over the past week, should snap back as the central bank appears to be gradually creating a new floor for China’s barometer of money market liquidity.

* The seven-day repo, which closed at 1.3974 percent, could rise as high as 1.8 percent in coming months due to the government’s gradual tightening campaign. The rate peaked near 2.2 percent in July last year when the PBOC began its first “fine tuning” of policy.

* One-year yuan non-deliverable forwards (NDFs) are expected to react strongly to China’s latest policy tightening measure, stoking expectations that it will lead to a resumption of appreciation before long.

* The benchmark NDFs will likely breach its three-month low of 6.5750 touched on Monday, possibly falling as far as 6.5500.

* Twelve-month yuan appreciation implied by NDFs could well breach 4 percent measured from the Chinese central bank’s daily mid-point but may not exceed its recent high of 4.55 percent hit on October 20, the highest yuan appreciation implied in the one-year NDFs since August 2008.

* But spot yuan is not expected to move much from levels near 6.83 against the dollar as China’s central bank typically tries to limit currency moves after such monetary policy changes.

* The government also appears unwilling to change its stable yuan policy as it awaits further signs of a recovery in exports, even after a jump in December’s trade figures.

Editing by Eric Burroughs