The central banks of China and Taiwan tightened policy on Tuesday to drain money from the banking system, marking intensified efforts in the region to head off inflation and cool asset bubbles.

A week after raising bank reserve ratio requirements, the People's Bank of China (PBOC) lifted the auction yield on one-year bills in its regular open market operation for a second week in a row, and by more than expected.

Taiwan also nudged up its overnight lending rate, the rate at which banks borrow and lend to each other, by one basis point to an eight-month high.

Financial markets, including high yielding assets, dipped because of expectations of further monetary tightening, with the Australian dollar slipping from a 26-1/2-month high against the euro and Shanghai shares <.SSEC> easing off their early highs.

The (bill auction) result shows the central bank signal that is still tightening liquidity to cool the urge in bank lending, said Shi Lei, analyst at Bank of China in Beijing. He added the market expected the one-year bill yield to rise to about 2.1 percent in coming weeks from 1.9264 percent at Tuesday's auction.

Indian bond yields also rose after the country's chief statistician said inflation might hit double digits by March, raising the prospect of policy tightening.

Some analysts said investors were unduly worried because the Chinese central bank's latest steps were only gentle restraints on the economy to prevent it from overheating. Most economists expect the central bank to wait with any substantial rise in benchmark deposit and lending rates until around the middle of the year.

China's bill auction is the latest in a series of steps to gradually withdraw the easy money made available to soften the impact of the global financial crisis, with Asia seen at the forefront of such a pull-back.

Shanghai shares later shrugged off China's bill auction results while the Chinese bond curve flattened, as traders welcomed the PBOC's decisiveness to act early in reining in excessive market liquidity.

Analysts said China has started tightening its grip on liquidity sooner than expected in a sign that Beijing was increasingly worried cheap cash could inflate property and share markets and stoke consumer inflation.


Last week, the central bank raised banks' reserve ratio by half a percentage point after reports that bank lending surged in the first week of the year, adding to overheating concerns fueled by blockbuster trade data for December.

In Taiwan, the central bank raised the overnight lending rate by one basis point to 0.12 percent, a significant move compared with usual adjustments of a mere 0.1 basis point.

As far as the overnight rate goes, it's still very low, said Tony Phoo, an economist with Standard Chartered in Taipei. What we can imply from this move is that the central bank is worried about high levels of liquidity, and rightly so. Analysts said the move reflected the central bank's growing unease about keeping rates at record low, though most economist expect the benchmark discount rate to stay on hold at 1.25 percent at least until March.

Confronted with an upward pressure on the Taiwanese dollar, the authorities in Taipei so far have sought to cool markets by imposing restraints on short-term capital inflows rather than raise the benchmark rate.

Across Asia, South Korea and India are tipped to be the first in the region to follow Australia's lead and raise policy rates.

The Reserve Bank of Australia raised interest rates in October, November and December, the first G20 nation to do so since the global credit crisis.

($1 = 6.82 yuan)

(Editing by Jacqueline Wong and Tomasz Janowski)