The shift to an easing policy comes amid increasing concern worldwide that the global economy is on a slippery slope as the euro zone struggles to decisively tackle its two year debt crisis. Global markets recovered early losses on the news.
China's central bank said on its website it lowered the reserve ratio by 50 basis points, effective Dec 5. That reduces the ratio for the biggest banks to 21 percent from a record high 21.5 percent, freeing up funds that could be used for lending to cash-strapped small firms.
This is a big move -- this is easing, said Stephen Green, China economist at Standard Chartered Bank in Hong Kong. It's a clear signal that China is on a loosening mode. The next move will be another RRR cut in January.
The cut in reserves releases between 350 billion yuan and 400 billion yuan ($54.8 billion to $62.7 billion) into the banking system, analysts estimated.
The People's Bank of China joins the central banks of Brazil, Indonesia, Thailand and the euro zone, among others, in easing monetary policy, a reflection of growing alarm that the euro zone debt crisis could drag the global economy back into a recession.
Ten of 19 analysts in a Reuters poll on Tuesday had predicted China would cut its bank reserves in December by 50 basis points. Eight had expected a move in the first quarter of 2012 and one not until the second quarter.
Purchasing managers' data on Thursday could confirm the pressure on China's manufacturers from the global slowdown after a flash PMI from HSBC last week suggested the sector was shrinking.
As recently as the middle of 2011, China was still tightening monetary policy to combat stubbornly high inflation, which rose in July to a three-year high of 6.5 percent.
However, as the economy felt the chill of a slowdown in global activity and inflation eased, Beijing adopted a policy of fine tuning, which targeted parts of the economy, such as loosening credit for cash-starved small firms.
A rare outflow of capital from the economy in recent months and a central bank decision in August to widen the base for calculating banks' reserve requirements had also tightened liquidity.
The cut in the reserve ratio was the first since December 2008 and marks a monetary policy shift to an easing bias.
It's a surprising move -- the market was not expecting the central bank to (cut RRR) so fast, said Shi Chenyu, an economist with the investment banking unit of Industrial and Commercial Bank of China.
The move sends a clear message that the central bank is ready to relax its policy stance.
Analysts said the China news would boost riskier assets on hopes that easing policy in China will boost the country's demand.
Indeed, stocks and the euro recovered from early losses after the China news and rose further after major central banks announced coordinated action to ease strains in financial markets resulting from the euro zone debt crisis.
However, analysts said they did not expect the central bank to cut interest rates anytime soon. It would favor further cuts in bank reserves first.
China's economic growth has eased for three straight quarters due to tight credit at home and flagging demand overseas. The economy grew 9.1 percent in the third quarter from a year earlier, its weakest pace since the second quarter of 2009.
Data since has suggested a further slowdown. A flash purchasing managers' index from HSBC on Nov 23 showed that China's manufacturing sector shrank in November, reviving worries of a hard landing for the world's fastest growing major economy.
HSBC releases the final figures on Thursday alongside an official survey that analysts forecast will show that the factory sector stalled in November.
A 50 basis point cut in the reserve requirement ratio helped boost risk assets during the London morning session. We expect further moderation in China's November PMI, released tomorrow, Barclays Capital said in a client note.
Such data would back a forecast this week from the Organisation for Economic Co-operation and Development forecast that China's growth will slow in 2012 to below 9 percent for the first time in a decade.
(Editing by Neil Fullick)