China's central bank signaled in its open market operations that it was tightening monetary conditions at a faster-than-expected pace in response to increasing concerns about the economy overheating.
Investors globally are following moves by China, which has been a driver of the global rebound, for signs of a policy change but Tuesday's move was not enough to change most traders' views that both rate rises and gradual yuan appreciation will likely wait until at least the second quarter.
Today's steps do not mean an imminent rate hike, said a trader at a major Chinese bank in Shanghai.
The central bank is still expected to step up efforts next via further fine-tuning of open market operations or a hike in banks' reserve requirement ratios, although that is unlikely to occur before the Lunar New Year.
The central bank is widely expected to avoid tightening too much ahead of the Lunar New Year next month, when many workers pull money out of the bank to spend on gifts or bring home to their families.
The People's Bank of China (PBOC) raised the yield on its 20 billion yuan ($2.9 billion) in one-year bills by about 8 basis points (bps) to 1.8434 percent after holding it steady in the previous 20 auctions, compared with a median forecast among traders that it would go up by just 4 bps.
It also drained a record 200 billion yuan via 28-day bond repurchase agreements, ensuring it will draw net funds from the market this week.
The steps come after reports that bank lending surged in the first week of the year to 600 billion yuan, adding to concerns fueled by blockbuster trade data for December that the world's third-largest economy is overheating.
Last week the central bank surprised the market by pushing up the yield on its 3-month bills by about 4 bps to 1.3684 percent after holding it steady since late August, sending stocks and commodities lower on worries about tougher fine-tuning of monetary policy.
Asian stocks fell on Tuesday on jitters about tighter policy in China although they trimmed earlier losses. The Shanghai Composite Index <.SSEC> also reversed course to end up nearly 2 percent, its biggest daily percentage rise in more than two weeks.
The market had been expecting the yield to rise at Tuesday's auction but the result, which came in near the top end of forecasts that ranged from 1.77 percent to 1.86 percent, suggested it aims to push up money market rates more quickly.
LONG-TERM RATE OUTLOOK INTACT
In response, bill and shorter-term bond yields in the secondary market mostly edged up.
Long-term bond yields were mostly steady since traders still doubt the central bank will raise benchmark lending and deposit rates by more than 54 bps this year, as is already priced into that part of the yield curve.
While the moves by the PBOC increased the likelihood of increases in policy rates, they will probably still not come until the middle of the year, after the central bank has already increased banks' reserve requirement ratios, said Isaac Meng with BNP Paribas in Beijing.
The reserve requirement is highly likely to be raised soon after the Lunar New Year, Meng said.
Interest rate swaps actually eased on profit taking and talk that they had been overshot after last week's surge of 16 to 45 basis points.
The benchmark Shanghai Composite Index <.SSEC> fell as much as 1 percent in early trade after news on the repo volume, but later made up for those losses, trading up 1.5 percent in mid-afternoon trade.
Analysts also took the repo operation as a further sign the PBOC is getting more aggressive at drawing cash from the banking system to rein in lending, although the final amount of net drains for this week will depend on Thursday's money operations.
Last week, the central bank conducted a net drain of 137 billion yuan, the biggest weekly net drain since late October, after mopping up a net 6 billion yuan the week before that.
Today's repo business is a signal that the central bank is acting to drain funds from the money market because it thinks liquidity is excessive, said Lin Chaohui, analyst at Guotai Junan Securities in Shanghai.
($1 = 6.82 yuan)
(Additional reporting by Jason Subler; Editing by Kazunori Takada)