New China cbank move points to gradual policy tightening for now

BEIJING (Reuters) - China’s central bank delivered a pointed reminder to financial markets and businesses this week that it is moving to a tightening policy bias, but analysts expect benchmark interest rates to remain unchanged and say any further measures will be limited as economic growth slows.

A woman walks past the headquarters of the People's Bank of China (PBOC), the central bank, in Beijing, June 21, 2013. REUTERS/Jason Lee/File Photo

The People’s Bank of China (PBOC) surprised markets on Tuesday by raising the interest rate it charges banks to borrow funds under its medium-term lending facility (MLF), which has been its tool of choice over the past year to channel funds more effectively to more vulnerable parts of the economy.

While the move was a very modest 10 basis points, it was the PBOC’s first increase in the MLF interest rate since its debuted the liquidity tool in 2014, and first time it has raised one of its policy interest rates since July 2011.

The rate increase came after the central bank made its largest weekly liquidity injection on record into money markets last week as China geared up for the long Lunar New Year holiday, fuelling speculation that it was loosening its stance.

“The PBOC’s move is to show it is still on the tightening side. It doesn’t want people to interpret too much (that last week’s) injection means easing,” said Chen Long, China economist at Gavekal Dragonomics in Beijing.


Speculation that Beijing was considering a shift away from its loose policy stance has intensified since May last year, when an “authoritative person” warned in the People’s Daily that China may suffer a financial crisis and economic recession if the government relies too much on debt-fuelled stimulus.

Even as China’s banks extended a record 12.65 trillion yuan ($1.84 trillion) of loans last year to help the government meet its official economic growth target, the PBOC has been slowly moving to raise the costs of funding by tightening liquidity in the interbank market.

This was also in line with Beijing’s objective to tackle asset speculation and to control financial risks. Over the course of last year, analysts have warned of irrational exuberance in markets ranging from housing to commodities and government debt, with a reliance on cheap interbank funding seen as one of the key factor fuelling the risks.

In August, the central bank switched to offering longer-term funding to banks through its open market operations, which carry a higher interest rate. Other moves in more recent months have also added to views that authorities are trying to coax debt-laden companies to deleverage by raising borrowing costs.


The MLF rate increase weighed on bonds on Wednesday, with the 10-year treasury futures for June delivery falling nearly 1 percent, though the benchmark seven-day repo dipped as the PBOC’s recent cash injections eased fears of a cash crunch.

Unlike early last year, when China got off to a shaky start, the world’s second-largest economy is entering 2017 on much more solid footing. Retail sales are growing in the double digits, corporate profits are rising and producer prices have increased rapidly, giving policymakers more room to manoeuvre.

But the central bank is not expected to be in any rush to tighten conditions too quickly, which could risk a sharper knock to economic growth ahead of a key party meeting in the autumn when a new generation of leaders will be picked.

“We cannot interpret this as a policy change. It is a fine-tuning. The general policy tone is prudent and neutral,” said Xu Hongcai, deputy chief economist at China Centre for International Economic Exchanges (CCIEE), a well-connected think-tank in Beijing.

One concern over higher rates is that it will be more expensive for China’s corporate sector to service its mountain of debt - equivalent to 169 percent of gross domestic product. A rise in debt defaults had already been predicted this year.

It would also increase financing costs for the government, which is expected to continue to ramp up its fiscal spending.

“I don’t think the government will really tighten monetary policy... It will cause problems very soon. You need to issue government bonds, carry out expansionary policy,” Yu Yongding, a professor at the China Academy of Social Sciences and a former member of the PBOC’s monetary policy committee, said in an interview last week.

But the limited measures so far do not point to higher borrowing costs in the real economy or for the heavily-indebted state firms, said Andrew Fennell of Fitch Ratings.

“In our view, the benchmark one-year lending rate remains a more meaningful gauge of borrowing costs for the real economy... Despite the liberalization of interest rates, in practice, borrowing costs in China continue to be heavily influenced by benchmark rates,” said Fennell.

Gavekal’s Chen agreed that the central bank’s room to tighten could be limited, as authorities worry about the risks from a slowing property market and a possible escalation in trade disputes with the United States under new President Donald Trump.

Chen also does not expect strong producer price inflation to last very long.

“I call this marginal tightening...I think it will last maybe until summer at best. It won’t be too long.”

Reporting by Elias Glenn and Kevin Yao; Additional reporting by Winni Zhou and John Ruwitch in SHANGHAI; Editing by Kim Coghill