China surprises with early bank reserve increase

The 0.5 percentage point increase in the reserve requirement ratio will take effect on January 18 and will apply to all banks apart from rural credit cooperatives, the People's Bank of China said on its website (www.pbc.gov.cn).

It was the first time that the central bank adjusted the ratio since it lowered the ratio in December 2008 as part of its loosening cycle at the time.

Many in the market had thought that China might increase RRR before it lifted interest rates, but the move came far earlier than expected amid concerns that a renewed surge in bank lending was flooding the economy with too much cash.

Shi Lei, an analyst at Bank of China in Beijing, said there could two or three more RRR increases before June.

The reserve ratio hike is a strong signal the central bank is stepping up efforts to absorb excessive liquidity, Shi said. The hike may drain about 200-300 billion yuan from the market but it really needs to drain about 700-800 billion yuan.

The RRR increase also followed two other tightening steps taken by the central bank on Tuesday.

The central bank 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.

This is exactly what happens with Chinese policy. They say fine tuning. It never happens that way. It's always nothing or boom, Ken Peng, an analyst with Citigroup in Beijing said.

When they reach a consensus, it happens very quickly, he added.

The tightening 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.

(Editing by Andy Bruce)