China Raises Bank Reserve Requirements as Inflation Quickens

China’s Inflation Accelerates to 5.5%, Fastest Since 2008
Employees of Zhengzhou Nissan Automobile Co. Ltd. work on the assembly line of the X-Trail sport utility vehicle in Zhengzhou, Henan province, China. Photographer: Nelson Ching/Bloomberg

China ordered lenders to set aside more cash as reserves after inflation accelerated to the fastest pace in almost three years in May and industrial production rose more than estimates.

A half percentage point increase announced by the central bank today and effective June 20 will take the ratio to a record 21.5 percent for the biggest lenders. The move was hours after data showing the inflation rate climbed to 5.5 percent.

Signs the world’s second-biggest economy is maintaining momentum after increases in borrowing costs and curbs on real estate may have encouraged policy makers to add to tightening measures. At the same time, weakness in the global economy and data yesterday showing slower bank lending and money-supply growth may make a decision on further raising interest rates a tougher call.

“Growth is moderating in response to recent policy measures, but at a very gradual pace, with little to suggest that Beijing needs to worry about a hard landing in coming months,” said Brian Jackson, an emerging-market strategist at Royal Bank of Canada. “Headline measures of inflation are above Beijing’s comfort level, with risks skewed to the upside.”

Jackson sees the key one-year lending rate rising by a quarter percentage point by the end of this month, with another move in the third quarter.

Swaps, Bonds

China’s interest-rate swaps surged and bonds slumped after the central bank announcement.

The one-year swap contract, the fixed cost needed to receive the floating seven-day repurchase rate, jumped 0.08 percentage point to 3.58 percent as of 4:15 p.m. in Shanghai, the biggest increase since March 21.

The yield on the 3.94 percent government bond due January 2021 climbed five basis points to 3.93 percent, the largest rise since April 26. The benchmark Shanghai Composite Index earlier closed 1.1 percent higher.

Today’s reserve-ratio increase “was quite a surprise but the central bank may be concerned about rising inflation expectations,” said Lu Ting, a Hong Kong-based economist with Bank of America Merrill Lynch. “It may also indicate that there have been inflows of foreign exchange especially from the trade surplus which was above $10 billion in April and May.”

Government Target

Lu estimates today’s move will drain about 370 billion yuan ($57 billion) from the banking system.

China has raised interest rates four times since September and allowed the yuan to gain about 1.6 percent against the dollar this year. Inflation has exceeded the government’s 4 percent target each month this year as companies including McDonald’s Corp. boost prices.

Still, the pace of inflation remains the slowest of the so-called BRIC nations, with the latest data showing annual rates of 6.6 percent for Brazil, 9.6 percent for Russia and 9.1 percent for India. China’s peak this year may be “slightly above” 6 percent in June, Bank of America said.

Food prices in China rose 11.7 percent in May from a year earlier as pork costs surged and vegetable prices rebounded late in the month, the statistics bureau said today. Low-income nations from India to Algeria are struggling with food prices that climbed to a record in February according to a United Nations gauge. The Food and Agricultural Organization index was up 37 percent in May from a year earlier.

Inflation Expectations

“Inflation pressure is still large,” Li Daokui, an academic adviser to the People’s Bank of China, said on his microblog today. “My personal view is that the policy focus should be on considering raising the deposit rate to adjust inflation expectations.”

China’s producer prices rose a more-than-estimated 6.8 percent in May and non-food inflation accelerated to 2.9 percent, the fastest pace in at least six years, today’s data showed.

Industrial output gained 13.3 percent last month from a year earlier compared with April’s 13.4 percent expansion. Retail sales, which are boosted by inflation, rose 16.9 percent after a 17.1 percent gain in April.

Fixed-asset investment excluding rural households expanded 25.8 percent in the first five months of the year, up from 25.4 percent in January-through-April.

The government is weighing the threat to growth from tightening measures against the danger that rising food and housing costs may fuel social instability. In March, Premier Wen Jiabao said a combination of inflation, corruption, and the gap between rich and poor could “even affect the government’s hold on power.”

Signs of unrest include clashes involving migrant street vendors in Zengcheng, Guangdong, this month and riots last month in Inner Mongolia. The government has detained activists this year after calls for so-called “jasmine” rallies, inspired by revolts in the Middle East and North Africa.

-- Zheng Lifei, Zhang Dingmin. With assistance from Michael Munoz, Shamim Adam, Victoria Ruan, Nerys Avery, Ben Richardson, Sophie Leung and Michelle Yun. Editors: Nerys Avery, Paul Panckhurst.

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