China signalled its intention on Tuesday to drain excess cash from its financial system by unexpectedly raising the yield on bills at a central bank auction and announcing new rules to curb hot money inflows. One of the measures directed against inflows - requiring banks to hold a minimum amount of dollars overnight - sparked a day of unprecedented yuan volatility, with the Chinese currency ending sharply up against the dollar.
Taken together, the moves flagged China's increasing concern about a surge in liquidity after the US Federal Reserve launched another round of quantitative easing, prompting some analysts to say monetary tightening may be closer than thought.
The expectations were fuelled by comments from two central bank deputy governors that the Fed's easing could lead to asset bubbles and inflation and that Chinese authorities were keeping a close eye on the situation. "China still has a strong momentum of rapid credit expansion," said Du Jinfu, one of the deputy governors, in summing up the challenges facing the central bank.
"There is obviously an increase in cyclical macro-economic risks such as excessive liquidity, inflation, bad debts and asset bubbles," Du told a financial conference. Shortly before Du's comments, the central bank surprised markets by ramping up the yield on one-year bills to draw cash out of the financial system.
It sold the bills at a yield of 2.3437 percent, more than 5 basis points higher than levels at auctions since just after the central bank raised its benchmark interest rates in mid-October. Markets were even more surprised by the yuan's moves on the day. The Chinese currency registered its largest intraday price movement since its July 2005 revaluation after the foreign exchange regulator imposed a minimum on forex positions that banks must hold overnight.