PBOC gives hints of policy pause to assess impact

SHANGHAI: China's central bank looks poised to end a streak of lifting bank reserve requirements every month since November as a slowdown in foreign capital inflows gives it room to relieve very tight money market conditions.

The People's Bank of China (PBOC), which has not changed the reserve level in July, appears to have eased back from its monetary tightening campaign as a series of interest rate and reserve requirement rises collide with a domestic slowdown and weaker global growth -- on top of the troubles in the United States and Europe.

Analysts and traders say a slowdown in the tightening -- including a halt in policy rate hikes and less-frequent RRR increases -- may now be taking shape as the government reviews their full impact since being launched last October.

Some market players are starting to think that a partial rollback of the aggressive policy tightening could happen within the next few months.

China's very flat interest-rate swap curve -- with one- to five-year swap rates within basis points of each other -- shows the central bank has had some success for now in clamping down on liquidity.

"A period during which the PBOC has sternly implemented a monetary tightening policy has apparently ended, and a period of observation appears to have already begun," said Zheng Weigang, a senior securities trader at Shanghai Securities.

"To tighten or not to tighten for the rest of this year is a question to be answered, but we expect a new policy direction to emerge in a couple of months or so."

The new direction will become more apparent when a slew of uncertainties at home and abroad settle down, analysts say.

Two particular questions are key: have the RRR increases since November lowered the amount of liquidity in the financial system? and will the slowdown of capital inflows persist?

The potential external threats to China's exports and overall economy add to the reasons to take a break on policy.

TOO TIGHT LIQUIDITY

When the PBOC last raised RRR in mid-June, it may not have expected the resulting money market squeeze to last for two months.

The seven-day repo rate , the main barometer for short-term liquidity supply, has mostly lingered above the 5 percent level since then, compared with a 3 percent rate on short-term fundraising costs that banks consider acceptable, dealers said.

The central bank refrained from draining funds from the market via its government bond repurchase agreements in its regular open market operations on Tuesday and sold only a symbolic 1 billion yuan ($155 million) in one-year bills.

Traders widely expect the PBOC to continue injecting money into the market this week after it made a surprise net injection of 19 billion yuan last week to help ease the strain.

But the recent shortfall of money was worsened by brisk corporate activity around the middle of a year, including cash calls from having to pay annual dividends and taxes, as well lenders having to meet mid-year regulatory requirements such as loan-to-deposit ratios, traders said.

Some banks have even shifted to doing more trading in money markets rather than bond and swap markets to take advantage of the higher rates, but even that additional activity has not helped to bring down the stubbornly higher seven-day repo rate, traders said.

"Corporate activities will ease in August and September," said a trader at a Chinese commercial bank in Shanghai. "Only then will the PBOC be able to decide whether liquidity conditions have been tightened enough and whether it will raise RRR again."

An unexpected slowdown in capital inflows in June may have caused the PBOC to put off an RRR hike this month.

The central bank, together with other financial institutions, bought 277 billion yuan ($43 billion) worth of foreign currencies flowing into China in June, down from 376 billion yuan in May.

While traders said a single monthly drop is not likely to impact policy, the market is watching for signs of an economic slowdown, especially with the troubles overseas.

The world's second-largest economy is clearly slowing, an intended outcome of the government's policy tightening to bring inflation under control.

It is widely forecast the economy will grow at a pace of 9-plus percent for the second half of this year. But some indicators, such as HSBC's flash PMI, have suggested that growth is cooling off.

Copyright Reuters, 2011