China: PBoC raises reserve requirement again

• The People’s Bank of China (PBoC) has today raised the reserve requirement for commercial banks by 50bp. This is the third hike in the reserve requirement in less than two months. The hike was widely expected and, as PBoC did not raise its leading interest rate, it might be a relief for stock markets.
• A rate hike this weekend now appears unlikely and PBoC might also be signalling a reluctance to raise interest rates. While we still expect a rate hike before year-end, the likelihood that it will not happen until Q1 11 has increased.
• With growth accelerating and inflation poised to increase to 5.5% y/y in early 2011, there is an urgent need for less accommodative monetary policy in China.

Details
PBoC has again increased the reserve requirement ratio (RRR) for commercial banks by 50bp (effective 20 December). For major commercial banks, RRR now is 18.5%. This is the third hike in RRR in less than two months. Importantly, PBoC did not raise its benchmark lending and deposit rates. There has been increasing speculation that PBoC would raise its lending interest rates – possibly as soon as this weekend – after the release of several important data for November was brought forward from Monday to tomorrow.

Assessment and outlook
The hike in the reserve requirement comes as no surprise. PBoC has recently failed to absorb sufficient liquidity through its open market operations and for that reason it was widely expected to use the RRR tool instead. It might come as a slight relief for the stock market that PBoC did not raise its benchmark lending and deposit rates today. In light of today’s move, it now appears unlikely that there will be a rate hike this weekend. By not raising interest rates today, PBoC might also be signalling a reluctance to raise interest rates, partly because PBoC fears it will boost speculative hot money inflows into China. We still expect a 25bp rate hike before year-end, although the likelihood that PBoC will not raise interest rates until Q1 11 has increased.

Recent economic data suggests that China’s growth is again accelerating, see Flash Comment – China: Exports and imports surge in November and inflation is poised to reach 5.5% y/y in early 2011. That said, we do not expect a nasty surprise in the November inflation data to be released tomorrow (Danske Bank: 4.6% y/y, consensus: 4.7%, market speculation is that it could exceed 5% y/y). However, we do believe PBoC is behind the curve in its monetary tightening. Real deposit rates are currently negative and according to a simple Taylor rule based on current inflation and current output gap, PBoC’s benchmark lending rate should currently be 100bp higher (see chart). In our view, interest rates do matter in China, particularly for asset prices, and it will not be enough to curb lending growth. Data released earlier today showed that house prices have again started increasing, albeit the year-on-year growth in house prices continues to decline.

Chinese policymakers are this weekend convened for the important Central Economic Work Conference, where they will have to agree on macroeconomic targets for 2011. In the usual Chinese understatements, they will signal a shift in monetary policy from ‘moderately loose’ to ‘prudent’ and this will include lower targets for credit growth next year. In our view, it will eventually also include interest hikes (we expect four 25bp hikes over the next year) and a faster appreciation of CNY.
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