SHANGHAI — China's announcement of its fourth bank reserve ratio hike of 2008 on Monday is likely to boost bond yields and the yuan's dollar exchange rate and fuel expectations of more anti-inflation steps in the medium term.
Right after news of a rise in inflation, the central bank announced a 0.5 percentage point hike in reserve requirements banks must place with it, taking the ratio for big banks to a record 16.5 per cent when the increase takes effect on May 20.
China said its annual consumer price inflation quickened to 8.5 per cent in April from 8.3 per cent in March, lingering near a 12-year high of 8.7 per cent in February and higher than economists' forecast of 8.3 per cent.
“Inflation appears to have entered a vicious cycle and may linger for two or three years,” said economist Wang Haoyu at First Capital Securities in Shenzhen.
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“The bank reserve hikes won't be able to solve the inflation problem. Interest rate hikes are the only way to effectively curb inflation,” he said, forecasting that authorities would eventually be forced to raise rates and sacrifice growth for economic stability.
The markets believe a widening gap between Chinese and U.S. rates, as the Federal Reserve has cut aggressively, has deterred the Chinese central bank from lifting its official rates so far this year, but the Fed is now showing signs of a pause in rate cuts.
Shi Lei, analyst at Bank of China in Beijing, noted that the latest reserve ratio hike came earlier than expected, suggesting the central bank was anxious to clamp down on excess liquidity.
“The risk that inflation may accelerate in coming months is rising, increasing the possibility of an interest rate hike next month,” Mr. Shi said.
Bond traders said they expected the yields for government bonds would rise across the curve in coming weeks, with the medium and the long end rising about 5 basis points.
Already on Monday, the indicative five-year government bond yield had edged up 0.27 basis points to a one-month high of 3.52 per cent in response to the April inflation data.
The weighted average rate of seven-day bond repurchase agreements, the barometer of China's short-term liquidity, should remain largely above Monday's closing level of 3.2033 per cent in coming weeks due to official monetary tightening and a string of small initial public offerings, traders said.
In the foreign exchange market, the only Chinese financial market still open when the central bank announced the reserve hike, the yuan closed higher but was little changed from its level before the news. It ended at 6.9882 to the dollar, up from Friday's 6.9918.
“The quick announcement of a bank reserve hike shows the government's determination to curb inflation,” said a dealer at a European bank in Shanghai.
“The yuan is expected to continue to be one of the central bank's tools in the battle, so its appreciation trend should remain intact in the medium term,” he said.
Several dealers expected the yuan to rise to between 6.93 and 6.95 versus the dollar by the end of May, translating into a monthly gain of 0.5 to 0.9 per cent.
They maintained their forecasts for the yuan to rise 8.5 to 10 per cent for all of 2008, taking into consideration its jump of 4.2 per cent in the first quarter of this year.
However, dealers said the reserve hike might briefly slow the yuan's rise this week because the central bank has, since last August, required many banks to settle reserve changes in dollars rather than yuan, temporarily boosting dollar demand.
Analysts expected the stock market to fall 1 to 2 per cent on Tuesday in volatile trade, pressured by both the reserve hike and a 7.8 magnitude earthquake in Sichuan Province on Monday, which caused buildings to sway as far away as Shanghai and Bangkok.
“Sichuan-related shares and insurance shares will be affected by the quake,” said Chen Jinren, senior stock analyst at Huatai Securities in Nanjing. “Adding the bank reserve ratio hike, the market's near-term trend has become quite uncertain.”
China's main stock index ended up 0.37 per cent at 3,626.982 points on Monday but was off its intraday high of 3,668.857, set around the time the earthquake hit in late afternoon trade.
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