China c.bank signals no tightening until February

The People's Bank of China on Tuesday signalled that it would keep official interest rates stable until early February by allowing the auction yield of its one-year bills to rise a moderate 11 basis points, traders said.

In its regular open market operations, the central bank used 14-day bond repurchase agreements for the first time in three years to help drain liquidity, a sign that it would also refrain from raising bank reserve requirement ratios (RRR) ahead of the Lunar New Year, which falls on February 3 this year.

The operations were a hint of the PBOC's monetary stance for now -- to help China's benchmark seven-day repo rate find a firm floor at 2.4% on Tuesday.

The central bank has recently relied on new tools such as RRRs to manage the massive liquidity in its financial system and persistent capital inflows chasing faster yuan appreciation, making its open market bill auctions a key indicator of its monetary policy intentions.

"With consumer spending running into its annual peak in the second half of this month due to the Lunar New Year holiday, there will be little chance for the PBOC to tighten if it does not do it right now," said Su Zhenhua, senior money and bond market analyst at Taikang Asset Management Co in Beijing.

"Tuesday's open market operations signal a tightening possibility has almost been ruled out for January, although it may strengthen it in days just ahead of the Lunar New Year."

Lunar New year Surprise

The PBOC auctioned 1 bn yuan (USD 151 mn) of one-year bills in operations on Tuesday at a yield of 2.7221% from last week's 2.6167%, the third week that it allowed the auction yield of its bills to rise moderately.

Traders said such a move had two intentions.

The PBOC wants the market to know that further tightening is still on the cards due to high consumer inflation.

It may also want to let its auction yields gradually approach higher secondary market yields so as to restore open market operations as one of the tools to drain liquidity, traders said.

The PBOC also drained 60 bn yuan via 14-day repos, but traders said this tenor of repos is sparely used, only for the expediency of adjusting money market supply during the Lunar New Year holidays, such as was the case in February 2008.

And the PBOC appears to have quickly reached its goal.

The weighted average seven-day government bond repo rate rose 8 basis points to 2.46% on late Tuesday morning from 2.38% at Monday's close when it plunged nearly 400 bps from a three-year high of 6.3680% hit late in 2010, propelled by banks' customary lending spree at the start of the year.

"There is a traditional early-year liquidity indulgence, and inflation conditions are not expected to improve overnight," said a trader at a Chinese state-owned bank.

"So it may actually not be a surprise if the PBOC gives the market another Lunar New Year surprise with a tightening as it did last year."

Inflation in November reached a 28-month high of 5.1%. December consumer price data will be announced later this month.

The PBOC announced a rise in RRR on February 12, 2010, two days ahead of the Lunar New Year.

RRR hikes typically take effect two weeks after their announcement and the effect of a pre-holiday move will come just in time to absorb huge liquidity flowing into the market right after the holiday as consumers save year-end bonuses and other money for the new year, among other sources.