In Much-Anticipated Move, China Cuts Reserve Requirement Ratio, Joins Reflation Race

After sell-side analysts had been begging for it, pardon, predicting it for months, the PBOC finally succumbed and joined every other bank in an attempt to reflate, even as pockets of inflation are still prevalent across the country, although the recent disappointing economic data was just too much. Overnight, the Chinese central bank announced it was cutting the Reserve Requirement Ratio by 50 bps, from 20.5% to 20.0%, effective May 18. The move is expected to free up "an estimated 400 billion yuan ($63.5 billion) for lending to head-off the risk of a sudden slowdown in the world's second-largest economy" as estimated by Reuters. "The central bank should have cut RRR after Q1 data. It has missed the best timing," Dong Xian'an, chief economist at Peking First Advisory in Beijing, told Reuters. "A cut today will have a much discounted impact. So the Chinese economy will become more vulnerable to global weakness and the slowing Chinese economy will in turn have a bigger negative impact on global recovery. Uncertainties in the global and Chinese economy are rising," he said. The irony, of course, is that the cut, by being long overdue, will simply accentuate the perception that China is on one hand seeing a crash in its housing market and a rapid contraction int he economy, while still having to scramble with high food prices (recall the near record spike in Sooy prices two weeks ago). In the end, the PBOC had hoped that it would be the Fed that would cut first and China could enjoy the "benefits" of global "growth", and the adverse effects of second hand inflation. Instead, Bernanke has delayed far too long. When he does rejoin the race to ease, that is when China will realize just how short-sighted its easing decision was. In the meantime, the world's soon to be largest source of gold demand just got a rude reminder that even more inflation is coming.

More from Reuters:

The cut of RRR to 20.0 percent from 20.5 percent for big banks still has analysts forecasting another 800 billion yuan's worth of cuts to have been earmarked for the rest of the year.


The central bank announced its first cut in RRR in three years on Nov. 30 last year. That move took the rate down from a record 21.5 percent. The second cut in this easing cycle was delivered in February.


Lowering RRR for banks helps China offset sluggish capital inflows that have been hit by skittish investors wary of investing their funds in higher-risk emerging markets at a time of global economic uncertainty driven mainly by Europe's festering debt crisis.


Crucially, an RRR cut would help Beijing meet its target of growing money supply by 14 percent in 2012. Data on Friday showed annual M2 money supply growth running at just 12.8 percent in April.


China's bank lending had trumped forecasts to spike to 1.01 trillion yuan ($160 billion) in March, a sign of fresh traction in Beijing's bid to boost credit creation to support the cooling economy.


The surge in lending was the biggest monthly extension of credit since January 2011, when new loans last topped 1 trillion yuan, holding out hope that China's economy would not only avoid a hard landing but pick up speed again later this year.


Chinese leaders, however, are wary about inflation risks given rising global commodity prices and remain determined to cool down the property sector to ward off a speculative bubble.


The deep-pocketed government has also cut taxes for small firms, which are vital for generating economic growth and jobs, to help them cope with a credit squeeze and weaker exports.

But the bigger problem for the economy may not be the supply of credit but demand for it, given that the European Union - China's single biggest export market - is battling recession again, consumers in the United States are still paying down debt and China's domestic demand is looking limp.


That implies to some that policy has to become looser still.

And that implies far more inflation is coming down the road to the country, which unlike the US, still sees food and energy as part of its inflation equation, and in turns leads people to consider alternatives to a devaluing currency. Such as silver and of course gold. And so a full repeat of 2011 is now fully in the cards.


The chart above also shows why between India and China, there will always be ever more demand for a real currency.

And, finally, a chart from Nomura, which shows why in the grand scheme of things RRR-moves have virtually no impact on the market: