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`Irrationally Low' Bill Yields Hamper PBOC's Inflation Fight: China Credit

The lowest yields at Chinese auctions in more than three years are curbing demand for central bank bills, hampering efforts to drain cash from the financial system as inflation gathers pace.

The People’s Bank of China sold 1 billion yuan ($150 million) of one-year bills to yield 2.34 percent on Nov. 30, 70 basis points less than the rate on similar-maturity existing securities, according to data compiled by Bloomberg. The sale raised the least amount at a weekly auction since October 2007 and seven times the average yield spread for 2010. Consumer prices rose 4.4 percent in October, the most in 25 months.

“The central bank is facing greater pressure to soak up liquidity as the consensus is that November’s inflation rate was even higher than October’s,” said Wang Mingfeng, a fixed-income analyst at Citic Securities Co., the nation’s largest listed brokerage. “Bill auction rates may have to rise to reflect gains in trading as current levels are irrationally low.”

The People’s Bank of China raised lenders’ reserve requirements twice last month and announced in October the first interest-rate increase since 2007, seeking to tame inflation as prospects for appreciation of the yuan draw funds to the country. The central bank may step up debt sales to soak up inflows, Ma Delun, a deputy governor, said Nov. 29, three days after the Finance Ministry failed to draw enough demand at a bill auction for the first time since June.

Photographer: Nelson Ching/Bloomberg

The People’s Bank of China raised lenders’ reserve requirements twice last month and announced in October the first interest-rate increase since 2007, seeking to tame inflation as prospects for appreciation of the yuan draw funds to the country. Close

The People’s Bank of China raised lenders’ reserve requirements twice last month and... Read More

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Photographer: Nelson Ching/Bloomberg

The People’s Bank of China raised lenders’ reserve requirements twice last month and announced in October the first interest-rate increase since 2007, seeking to tame inflation as prospects for appreciation of the yuan draw funds to the country.

Sales Slump

The central bank has on average raised 33 billion yuan at this year’s weekly sales of one-year bills. Yesterday’s sale of 1 billion yuan of three-month notes by the monetary authority was also the smallest since 2007 and compares with a 2010 average of 38 billion yuan.

“The PBOC has been scaling back auctions but there’s an oversupply of these notes anyway because of expectations for more interest-rate increases,” said Jiang Mingbo, who helps manage 25 billion yuan at ICBC Credit Suisse Asset Management Co. in Beijing. “The bill-rate gap with the secondary market is also stopping buying.”

Auction rates for one-year bills have climbed 25 basis points, or 0.25 percentage point, since the People’s Bank of China raised its benchmark 12-month deposit rate on Oct. 19 by a quarter of a percentage point to 2.5 percent. Yields for existing securities jumped 90 basis points to 3 percent in that time, touching a two-year high of 3.04 percent on Nov. 30.

The Finance Ministry sold 11.6 billion yuan of three-month securities in a 91-day bills sale on Nov. 26, falling short of its 20 billion yuan target.

Further Tightening

The central bank may step up tightening this month by selling more bills in open-market operations or raising banks’ reserve requirements further to sterilize increased cash in the financial system, according to Yang Mo, a money dealer at Industrial Bank Co. in Shanghai. “So the PBOC needs to let bill yields rise to attract demand to meet the goal of soaking cash through open-market auctions,” she said.

The yuan was little changed yesterday at 6.6613 per dollar. The currency strengthened 2.4 percent since a two-year peg ended on June 19, and 12-month non-deliverable forwards reflect bets for a 2.3 percent advance in the coming year.

Benchmark 10-year bonds rose for a fifth day, lowering the yield on the 3.29 percent note due in September 2020 by one basis point today and 18 basis points this week to 3.89 percent, according to prices from the National Interbank Funding Center.

Five-year contracts on the nation’s debt fell 3 basis points yesterday to 68, according to CMA prices in New York. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

Rate Outlook

One-year interest-rate swaps based on the floating seven- day repurchase rate jumped a record 83 basis points last month to 3.18 percent. The rate has since slipped to 3.11 percent.

Policy makers are reluctant to let bill yields climb at auctions as increases may fuel speculation of further interest- rate rises, encouraging capital inflows that are stoking inflation, Citic’s Wang said. He predicted the central bank will allow the one-year rate to increase to about 2.5 percent in the “near term” and may tighten lenders’ reserve requirements further unless bill sales prove more successful in draining funds from the financial system.

Government data this month will show consumer prices climbed 4.7 percent from a year earlier in November, the most since August 2008, according to the median estimate of economists surveyed by Bloomberg. The central bank bought 519 billion yuan of foreign exchange from local lenders in October, 79 percent more than the previous month and the most since April 2008, according to data released Nov. 26.

Inflation may average 5.5 percent in 2011, up from an estimated 3.2 percent this year, Standard Chartered analysts led by Stephen Green wrote in a Nov. 18 report. The U.K. lender said it expects the central bank to raise interest rates four more times by the end of June, boost lenders’ reserve-requirement ratios by 50 basis points as many as five times and allow yuan appreciation to accelerate to a 7 percent annual pace as it tries to stem price gains.

--Belinda Cao. With assistance from Andrea Wong in Taipei. Editors: James Regan, Laura Zelenko.

To contact Bloomberg News staff for this story: Belinda Cao in Beijing at +86-10-6649-7570 or lcao4@bloomberg.net;

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net.

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