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China tightens money policy to record level

Beijing, November 10, 2007

China's central bank, battling to restrain growth in the money supply and inflation, announced it was lifting the proportion of deposits that commercial banks must keep in reserve to a record high.

The 0.5 percentage point rise in banks' reserve ratios, the ninth this year, will take effect on Nov. 26 and bring the ratio for big banks to 13.5 percent, the central bank said on Saturday.

The monetary tightening came two days after the central bank issued its strongest warning so far this year about rising prices, saying: "Our consumers' expectations of inflation are growing, and will probably push up inflation further."

This year inflation has become an economic and potentially political problem for the government as the economy expands at double-digit rates and China's ballooning trade surplus pours money into the real estate and stock markets.

Inflation hit a 10-year high of 6.5 percent in August, before declining slightly to 6.2 percent in September. October inflation data are due to be announced on Tuesday, and financial markets are expecting a rate of at least 6.4 percent.

China has also raised benchmark interest rates five times this year in an effort to keep bank deposit rates from lagging far behind inflation.

In its third-quarter policy report on Thursday, the central bank also sounded the alarm about China's real estate market, where a construction boom fuelled by bank lending has been pushing prices up by over 10 percent a year in many big cities.

"Mortgage lending is growing very fast, and there are already signs of default risks," the report said. "If housing prices fluctuate, they could easily cause a surge in non-performing loans for commercial lenders."    

Chinese authorities appear to have concluded in recent months that the traditional method of fighting inflation -- interest rate hikes -- is not working well.

Although the financial markets expect at least one more interest rate hike this year, China may not have much more room to use this tool because of the shrinking gap between its rates and higher US rates.

The gap has narrowed to just 0.6 percentage point from 2.4 percentage points early this year as the US subprime loan crisis has forced cuts in US rates. If the gap disappears, the flood of speculative money into China could increase.

So authorities are keen instead to take more money directly from banks through steps such as reserve ratio rises. They are also mounting a strong campaign of "window guidance" -- advice given in private meetings with commercial bankers -- to persuade banks to curb their lending.

"The reserve ratio rise is a signal that the central bank is still in liquidity tightening mode and is very keen to control loan growth," said a trader at a European bank in Shanghai.

"The new level of 13.5 percent suggests there is no ceiling, so the bank may raise reserve ratios again this year."

The central bank's third-quarter report also indicated it was prepared to use appreciation of the yuan against the dollar more aggressively to fight inflation, saying coordinated use of the exchange rate would "help stabilise expectations of inflation."    

The latest reserve ratio rise may therefore fuel speculation that the yuan's climb will accelerate in coming months. In the week through Friday, the yuan rose to 7.41 against the dollar, its highest level since it was revalued in July 2005. It was the yuan's biggest weekly gain since revaluation.

For most of the year, China's financial markets reacted calmly to the central bank's monetary tightening. But recent volatility suggests the latest reserve ratio increase could have a substantial impact on the markets. -Reuters




Tags: China | monetary |

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