When we reported last night's Chinese economic data dump we said: "Expect to see renewed calls on the PBoC to hike rates imminently." As it occasionally happens, we were rather spot on: per Bloomberg: "China ordered lenders to set aside more cash as reserves after inflation accelerated to the fastest pace in almost three years in May and industrial production rose more than estimates. A half percentage point increase announced by the central bank today and effective June 20 will take the ratio to a record 21.5 percent for the nation’s biggest lenders. The move was hours after data showing the annual inflation rate climbed to 5.5 percent." As we noted last night after reporting the latest Chinese data, while the economy is once again heating up, risks of outright stagflation have been reduced now that various other metrics aside from inflation also beat expectations, putting the onus squarely on the PBoC. And the central bank did not disappoint. That said, since the RRR-hike route has taken China nowhere fast, and with inflation at a 3 year high, the PBoC's next decision of an outright rate hike will be far more complex: "Signs the world’s second-biggest economy is maintaining momentum after increases in borrowing costs and curbs on real estate may have encouraged policy makers to add to tightening measures. At the same time, weakness in the global economy and data yesterday showing slower bank lending and money-supply growth may make a decision on further raising interest rates a tougher call." In this case, we expect to see doctored CPI data to begin dropping in June and onward, unless there is another climatic disaster which really sends the angry mobs loose.
Below we present Goldman's take:
Asia Policy Watch: Another 50-bp RRR hike by the People’s Bank of China
The People’s Bank of China (PBOC) announced today that the reserve requirement ratio (RRR) will be raised by 50 bp, to be effective June 20. After this hike, the official RRR for large banks will be 21.5% and 19.5% for small and medium banks. However, given the usage of the Dynamic Differentiated RRR, the actual RRR varies for different banks.
We reiterate our view that the RRR is increasingly used as a regular liquidity management tool, to a large extent in replacement of central bank bill issuance, because it tends to be 1) more proactive [because it is a government order as supposed to a negotiation in the case of bill issuance]; 2) the high profile in terms of its signaling effect; and 3) cheaper [the required reserve interest is 1.62%, significantly lower than the 3%+ bill rate]. As a result, the RRR hike itself does not necessarily imply a net tightening of monetary policy, just as an issuance of PBOC bills itself does not necessarily imply a net tightening if the amount of expiring bills and FX inflows are equally large or even larger. We do not know for sure if it has been a net injection as the PBOC does not release FX position data on a real time basis. But judging from the rise in interbank rate in recent days there probably has been a net tightening.
The exact timing of the hike relatively early on a Tuesday afternoon is probably meant to be a signal to the market after the release of May inflation and activity growth data that the central bank is not in a hurry to loosen policy amid elevated yoy CPI inflation (5.5%) despite the relatively low level of industrial activity growth.
We continued to expect repeated RRR hikes going forward as it has been over the past half year. As we estimate the excess reserve ratio is still above 1%, the hike is not directly binding and the burden of net monetary tightening will still mostly fall on window guidance (explicitly or implicitly via the Dynamic Differentiated RRR). In the meantime, we expect the PBOC to allow currency appreciation (6% on an annual basis) to continue and hike benchmark interest rates (1 more hike of 25 bp in the rest of 2011, likely before the end of July).