Yellen's Shadow Looms Large Over China's Central Bank Policy

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  • People’s Bank of China tightened policy hours after the Fed
  • Officials say domestic drivers remain their primary influence

Rabobank's Every Says China Is Least Free Major Economy

Call it the Yellen effect.

The Federal Reserve’s March 15 rate hike underscored a subtle shift at the People’s Bank of China: long reluctant to be influenced by global counterparts, it now appears to be in step with the U.S. 

That was displayed by the PBOC raising borrowing costs just hours after the Fed lifted interest rates last week. Observers see the objectives as supporting the yuan by keeping a lid on the interest rate differential and taming a surge in lending that’s fueled financial risk.

For all the domestic drivers, it’s hard to ignore the Fed’s policy path. Massive monetary stimulus in the U.S. and around the world since the global financial crisis means decisions in Washington and Frankfurt now reverberate to Beijing in a way they haven’t previously.

“Nobody can just sit there and pretend they’re in a different world from what the European Central Bank or the Fed are doing,” Nobel laureate Michael Spence, a professor at New York University’s Stern School of Business, said in an interview in Beijing. “There’s too much money flowing around. You could invent a world in which that would be irrelevant but that’s not the world we live in, and I think that’s true of every central bank including the PBOC.”

Chinese officials have said they aren’t following Fed Chair Janet Yellen or anyone else, and that domestic conditions are the dominant driver for tightening policy. PBOC Governor Zhou Xiaochuan said in press conference this month that monetary policy is prudent and neutral and won’t be altered because of interest rate differentials. Higher U.S. borrowing costs impact China by luring capital out of the country.

Read More: Zhou says rate differentials won’t lead to persistent speculation

“The interest rate differential can always motivate traders to make some short-term transactions, and money will move toward the place with higher interest rates,” Zhou said. “But in the medium term, every country’s interest rate is determined by its domestic economic conditions, such as its economic growth, employment, people’s confidence in the economy and inflation.”

The PBOC didn’t respond to a fax Friday seeking comment on its monetary policy settings.

Market expectations for Chinese borrowing costs show the PBOC still has room to partially match the two anticipated Fed rate increases this year, according to an analysis by Bloomberg application specialists. The interest-rate swap curve shows the estimated cost of funding at a future date, known as the forward-forward rate, is higher in China after both of the Fed meetings due in July and December.

One of those domestic drivers is a housing price bubble that authorities are determined to deflate after 45 percent of new loans last year went to mortgages, most for personal use. Other pressures include accelerating factory-gate prices and borrowing, which Bloomberg Intelligence estimates has pushed total debt to 258 percent of economic output.

The PBOC’s increased use of reverse repurchases and Medium-term Lending Facility interest rates has had the effect of “targeted” measures to prevent property sector risks because developers with high debt loads are more sensitive to higher borrowing costs, Financial News, the central bank’s newspaper, said in a commentary Monday, citing unidentified analysts.

Read More: People’s Bank of China Raises Borrowing Costs in Step With Fed

Still, not all are convinced. Economists say the lightning quick response to the Fed shows they have little option but to move in lock step. Stable domestic growth and improving market sentiment gives the PBOC an opportunity to tighten through the money markets, without hurting the economy by raising benchmark rates. The policy maneuver also helps support the yuan and thwart capital outflows.

“The Fed tightening is the catalyst for China’s raising borrowing costs in the open market,” said Wen Bin, an analyst at Essence Securities Co. in Beijing. “This situation will continue into the second half as long as China’s economy keeps steady.”