February 11, 2011

China Raises Reserve Ratios for Smaller Banks as Bond Yields Rise

Inflation curb measures ineffective as investors fear more rate hikes

China raised the reserve requirement ratios (RRR) for its small- and medium-sized banks in yet another effort to quell inflation, even as poor demand for bonds signaled investors’ fears that Beijing would order further interest rate hikes.

According to Reuters, the China Securities Journal on Friday cited unnamed sources who said that the nation’s central bank had individually tailored RRR for a number of banks at the conclusion of the lunar new year, which ended on Tuesday. The punitive new rates are another effort by Beijing to control rampant inflation, and were seen as necessary because of a “lending binge” during the first two weeks of January. As a whole, bank lending in January amounted to more than 12% of the country’s annual lending target and exceeded the central bank’s threshold of 1.2 trillion yuan ($182.2 billion).

The specter of rising inflation and China’s drive to control it through various measures, including interest rate hikes, took its toll on a Friday bond auction by China Development Bank (CDB). Demand was low and yield rose, with 10-year fixed-rate bonds, forecast at 4.44%, instead set at 4.62%; by midday that had risen another 10 basis points. Yield was also up on the 5-year and other offerings.

The announcement of key January economic data scheduled for next week is expected to indicate a substantial rise in the consumer price index (CPI); in December the CPI was 4.6%, and January’s number is expected to rise to 5.3%—the highest in more than two years.

As reported by AdvisorOne on Tuesday, the People’s Bank of China (PBOC) raised interest rates for the first time in 2011. On Thursday, it signaled another interest rate hike in the wings by setting the auction yield of its three-month bills over 36 basis points and letting it advance over the increase in three-month deposit rates that accompanied the Tuesday rate increase.

Next Tuesday traders will be waiting to see if the PBOC allows the yield on the benchmark 1-year bonds to exceed the official rate. That is thought to be an indicator that another interest rate hike will follow soon.

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