February 12, 2010 / 12:50 PM / 10 years ago

Instant View: China surprises with reserve requirement rise

BEIJING/SHANGHAI (Reuters) - China’s central bank surprised markets on Friday by saying it was raising banks’ reserve requirements by 50 basis points, effective February 25, the second such increase this year.

The move, which comes ahead of a week-long holiday in China for the Lunar New Year, had wide market impact. The dollar and European and U.S. bonds jumped broadly while stocks fell.

KEY POINTS:

— Many in the market had not expected such a quick increase in reserve requirements by the People’s Bank of China, given annual consumer inflation in January moderated to 1.5 percent from 1.9 percent in December.

— The central bank injected a net 604 billion yuan ($88.6 billion) in its open market operations in the past three weeks, including the impact of a punitive reserve ratio hike for selected banks last month.

— About 686 billion yuan in central bank bills are due to mature in March, up sharply from about 310 billion yuan in February, putting extra pressure on the PBOC to mop up that cash.

COMMENTARY:

QING WANG, ECONOMIST WITH MORGAN STANLEY IN HONG KONG, IN A NOTE TO CLIENTS:

“The RRR hike is a conventional tool that the PBoC relies on to sterilize excess liquidity created as a result of persistent FX inflows. FX inflows must have been persistently strong since January.

“Why now? Typically lots of liquidity is injected into the market before Chinese New Year holiday (which is tomorrow), and that liquidity needs to be withdrawn after the holiday somehow. And an RRR hike is the most cost effective way of doing so.

“We would like to reiterate this should not be viewed as outright tightening. The market should get used to it.”

MARTIN SOMMERSETH JAER, ANALYST, ARCTIC SECURITIES

“Chinese iron ore and other commodity imports in January 2010 decreased more on a month-on-month basis than a normal seasonal pattern would suggest.

“Although it is too early to say the underlying reason for this decline is reduced liquidity, we would expect a combination of more Chinese uncertainty and less available credit to, in fact, reduce Chinese commodity traders’ import appetite.

“Dry bulk (shipping) market players seem to expect a post-Chinese New Year dry bulk bounce back. If the underlying reason for the current sluggish Chinese demand side — and hence freight rates — in fact is Chinese tightening, we would not expect demand to pick up after the Chinese New Year.

“With no New Year party, dry bulk equities will clearly face headwind two weeks from now.”

CHENG CHENG-MOUNT, CHIEF ECONOMIST, CITIGROUP TAIWAN:

“This is earlier than thought but in line with expectations. After the rise of 1.5 percent in January CPI we didn’t think the inflation pressures were immediate, but the government appears worried about inflation.”

EUGEN WEINBERG, COMMODITIES ANALYST, COMMERZBANK:

“It’s going to hit prices. People are afraid it might impact the growth prospects of the Chinese economy. The tightening will lead to lower speculative buying.

“But Chinese monetary policy is still loose and China will still be growing, so this is no real concern, but it will take the excessive speculation and heat from the market.”

AMRITA SEN, ENERGY ANALYST, BARCLAYS CAPITAL:

“The way I see it, Chinese tightening is a positive thing for commodity markets in the medium- to long-term — it makes their growth much more sustainable.

“The worst thing that could happen to commodity markets would be for China’s growth to shoot to 15 percent then crash to 5 percent. The policy of tightening keeps their growth on a far more sustainable path.

“Markets may view it negatively in the short term as China might import less commodities, but in the longer term we definitely see it as beneficial for commodity demand.”

ZHANG YONGJUN, RESEARCHER AT CHINA CENTER FOR INTERNATIONAL ECONOMIC EXCHANGES IN BEIJING:

“The month-on-month CPI data suggests inflationary pressure is still in place; therefore, we think the central bank is being proactive in terms of draining liquidity.

“However, in terms of timing, it is quite sudden. Not a good time.”

GAVIN FRIEND, CURRENCY STRATEGIST, NABCAPITAL, LONDON:

“This has clearly caught the market on the hop. No one was expecting another rise in China’s reserve requirement so soon, and the fact that it has come at a time when markets are so sensitive to any negative news this has just added insult to injury.”

JANE FOLEY, CURRENCY RESEARCH DIRECTOR, FOREX.COM, LONDON:

“It’s no shock that they’ve tightened further, but yesterday’s Chinese CPI figures offered false hope that they perhaps wouldn’t be tightening for now.

“But if you look at the money supply data that also came out yesterday, it was very strong and we also had housing data at significant levels. So on the back of those data, the People’s Bank of China has decided to waste no more time and bring forward further tightening.

“It’s still very likely we’ll have more policy measures in the coming months.

“Looking at the Australian dollar on the news, it really went through the floor, so clearly people weren’t prepared to see tightening this week, perhaps on the benign CPI data, and it has the impact of paring the risk trade fairly dramatically.”

ZHU JIANFANG, CHIEF MACROECONOMIC ANALYST AT CITIC SECURITIES IN BEIJING:

“The RRR rise was expected, given relatively huge pressure on excessive liquidity and increasingly rising foreign currency reserves.

“With the hike in RRR, the central bank is meant to drain excessive liquidity and relieve pressure on funds outstanding for foreign exchange.”

LIU HAIDONG, ANALYST AT ESSENCE SECURITIES IN BEIJING:

“The market had been expecting such a move after the Spring Festival because of huge pressure to drain liquidity.

“Historically, the central bank has been active in withdrawing capital after the Spring Festival.

“The possibility of another one or two RRR increases in the next couple of months cannot be ruled out, because it only drains around 300 billion yuan ($44 billion) each time.

“But an interest rate hike will not come any time soon. We don’t think the PBoC will raise interest rates until the second quarter.”

SHI LEI, ANALYST AT BANK OF CHINA IN BEIJING:

“The RRR hike was as expected. The central bank needs to absorb back a huge amount of funds injected through its open market operations before the Chinese New Year.

“Even though the inflation threat is mild, the central bank has huge pressures to mop up excessive funds from commercial banks to reduce their urge to extend corporate loans.

“But the hike will still not fundamentally tighten liquidity too much and there will be more reserve ratio hikes upcoming.”

XIE XUECHENG, ECONOMIST WITH SOUTHWEST SECURITIES IN BEIJING:

“The reserve rate hike is a surprise, especially given consideration to the low consumer inflation in January and curbed lending in January.

“The central bank is sending a clear message to banks that it wants more reasonable lending and it is paying close attention to inflation.

“The reserve rate will become a normal tool for China to control lending and inflation, and with the frequent use of the tool, the authorities are likely to use fewer administrative measures like window guidance.

“If China’s CPI moves above 3 percent in March, China is likely to raise interest rates in April.

“However, the real impact of the 0.5 percentage point increase in the deposit reserve may be limited as banks still have extra deposit reserves with the central bank.” (Reporting by Zhou Xin, Michael Wei, Shen Yan, Karen Yeung and London and Taipei newsrooms; Editing by Jason Subler)

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