China's short-term money rates and the yuan are set to rise while equities may pull back from record highs after the latest hike in bank reserve requirements, but the reaction will be mild, analysts said on Thursday. The 0.5 percentage point reserve rise, to take effect on April 16, came several weeks earlier than many in the markets had expected.
Previous steps in the central bank's year-old monetary tightening cycle had routinely been announced at the weekend or after trade ended on Friday, apparently in an effort to reduce their psychological impact on the markets.
So the central bank's decision to announce its latest move on a Thursday could signal growing concern about excess liquidity in the markets and a new willingness to take action at short notice, some believe. But the sixth reserve requirement rise since last June merely confirms a monetary tightening bias that the markets had already expected to continue until at least late this year. So it will not change anything fundamental in the markets, analysts said.
"Hikes in bank reserve ratios have now become a routine tool for the central bank to fine-tune the economy. This mild 0.5 percentage point hike suggests the central bank will continue to use the tool in coming months," said economist Zhu Jianfang at China Securities in Beijing. In the foreign exchange market, dealers said the central bank might allow the yuan to rise a bit faster against the dollar on Friday or early next week, following a slowdown of appreciation over the past two months.
Partly in response to the announcement of the reserve hike, the yuan closed at 7.7243 against the dollar on Thursday after hitting an intra-day high of 7.7240, its highest level since it was revalued in July 2005.
But it has risen only 0.4 percent since early February, which translates into an annual pace of about 2.5 percent, compared with 3.4 percent last year. Seeking to use yuan strength to curb China's huge trade surplus, the central bank may now permit another leg up in the currency - though it remains very unlikely to permit faster appreciation in 2007 than 4 or 5 percent, traders said.
"Both the central bank and the market could use the reserve hike as an opportunity to push the yuan up slightly, compensating for the slower-than-expected appreciation so far this year," said a dealer at a major Chinese commercial bank in Shenzhen. The yuan could test the psychologically important level of 7.7200 on Friday or early next week, dealers said.
In the money market, the shortest rates are likely to climb on Friday as the market prepares for a roughly 160 billion yuan ($20.7 billion) drain from the reserve hike. Pressure on liquidity was already expected from this month's major initial public equity offer by China CITIC Bank, which is likely to raise $1 billion in Shanghai. Subscriptions to the offer could temporarily lock up several hundred billion yuan.
But longer-term bill and bond yields are likely to rise much less, partly because the central bank's adjustment to the reserve requirement may leave it willing to delay the next benchmark interest rate hike for some months. It last raised interest rates less than three weeks ago. The weighted average seven-day repo rate, a key measure of liquidity, stood at 1.9908 percent on Thursday.
"The seven-day repo could approach 2.1 percent tomorrow while short-term bill and bond yields could rise one or two basis points," said a money trader at a major bank in Nanjing.
Some believe the repo could temporarily rise well over 3 percent in coming weeks as the IPO is conducted and heavy fund demand for a long public holiday in May emerges. The benchmark Shanghai composite index, which climbed to an all-time high close of 3,319.140 points on Thursday - up 24 percent since the start of this year - could fall as much as 3 percent on Friday, analysts said.
Many had already been predicting a short-term pull-back as investors took profits after an almost uninterrupted rise over the past two weeks. But with newly created mutual funds still liquid and keen to load up on stocks, any extended drop appears unlikely. Analysts see very strong support for the index around 3,000 points, where the market peaked in January and February.
"The central bank has hiked bank reserve ratios only gradually and in small size each time, indicating authorities don't want monetary tightening steps to have too big an impact on the markets," said stock analyst Zhang Qi at Haitong Securities.
Huatai Securities analyst Chen Jinren said the index could still hit 3,500 in coming weeks, aided by buying of blue chips in anticipation of China's launch of stock index futures in the first half of this year.