China Two-Year Swap Rate Jumps as China Raises Borrowing Costs

China’s two-year interest-rate swaps rose the most in three months and the yuan traded near a 17-year high after the central bank raised borrowing costs to curb inflation.

The one-year deposit and lending rates were increased a quarter of a percentage point each to 3.5 percent and 6.56 percent, after official data on June 14 showed consumer prices climbed at the fastest pace in almost three years in May.

China lifted rates for a third time this year yesterday, while policy makers have also ordered banks to set aside more cash as reserves on six occasions. Inflation may have surpassed 6 percent last month to the highest level since July 2008, according to economists surveyed by Bloomberg before the data are released on July 9.

“We continue to project another 25-basis point hike sometime in the fourth quarter,” economists from Singapore- based DBS Group Holdings Ltd., led by David Carbon, wrote in a research note today. “The latest situation reconfirms our view that the probability of premature loosening of monetary policy is extremely small. The asset-inflation problem hasn’t been resolved; property prices in many smaller cities have continued to surge.”

The two-year interest-rate swap climbed nine basis points to 3.635 percent as of 4:47 p.m. in Shanghai, the biggest increase since April 6, according to data compiled by Bloomberg. Buyers of the contracts receive the deposit rate for one year, after which the floating payment is reset for the second year.

Weaker Yuan Fixing

The yuan traded at 6.4658 per dollar, little changed from yesterday’s 6.4670, according to the China Foreign Exchange Trade System. The currency touched 6.4599 on July 4, the strongest level since the country unified official and market exchange rates at the end of 1993. In Hong Kong’s offshore market, the yuan was also little changed at 6.4650.

The People’s Bank of China set the yuan’s reference rate 0.03 percent weaker at 6.4732. Twelve-month non-deliverable forwards were at 6.3928 in Hong Kong, a 1.1 percent premium to the onshore spot rate, according to data compiled by Bloomberg.

Banny Lam, a Hong Kong-based economist at CCB International Securities, said China may now ease off the tightening pedal for the rest of 2011 on signs the economy is slowing.

China’s manufacturing expanded in June at the slowest pace in more than two years, according to the findings of purchasing managers’ surveys released this month by the China Federation of Logistics and Purchasing on July 1. The Purchasing Managers’ Index decreased to 50.9, from 52 in May.

‘Last Rate Hike’

“It should be China’s last rate hike this year and the government will focus on economic growth rather than curbing inflation in the second half,” said Lam. “We expect the yuan to gain 3 percent to 5 percent for the rest of the year on the back of strong economic growth.”

Consumer prices climbed 5.5 percent in May from a year earlier, the most in 34 months, official data show. The median estimate of 30 analysts surveyed by Bloomberg is for the yuan to appreciate 2.7 percent by the end of the year to 6.3 per dollar.

China’s money-market rate declined the most in more than four months, after the central bank kept the yield on three- month bills unchanged, fueling speculation the central bank will limit interest-rate increases.

The seven-day repurchase rate, which measures interbank funding availability, dropped 182 basis points, or 1.82 percentage points, to 5.60 percent, the biggest decline since Feb. 24, according to a weighted average compiled by the National Interbank Funding Center. It touched a three-year high of 9.2 percent on June 24.

‘Wait and Watch’

The People’s Bank of China kept the rate on the bills at 3.0801 percent, after pushing up yields at the previous two sales, according to a statement on its website. The central bank sold 30 billion yuan ($4.6 billion) of the securities today and offered 60 billion yuan of 91-day repurchase agreements.

“The cash shortage will ease gradually in the short term because the likelihood of a reserve-ratio hike is quite low this month,” said Liu Junyu, a bond analyst at China Merchants Bank Co., the nation’s sixth-largest lender. “The central bank may wait and watch for a while before considering the next interest- rate hike.”

The yield on the 3.83 percent government bond due March 2021 dropped two basis points to 3.88 percent, according to the Interbank Funding Center.

--Fion Li, Judy Chen. Editors: Simon Harvey

To contact the reporter on this story: Fion Li in Hong Kong at fli59@bloomberg.net; Judy Chen in Shanghai at xchen45@bloomberg.net.

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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