Newswires are reporting that China’s finance ministry failed to attract enough demand for a bill sale on Friday — the first time this has happened since June.
This is important since the failure could indicate a shortage of cash at banks following the lifting of reserve requirements twice in this month.
According to North Square Blue Oak, a brokerage which specialises in Chinese markets, China’s central bank, the PBoC, managed to sell only 11.6bn yuan ($1.7bn) of three-month bills instead of the 20bn yuan planned. The auction drew an average yield of 2.7372 per cent.
But while some are interpreting the auction failure as a signal of interest rate hikes to come, NSBO believes the PBoC will stick as long as it can to alternative tightening measures in a bid to dodge an outright mismatch between the interest it collects on its US security holdings and the interest it pays out to domestic creditors:
Impact: While the monetary authorities have realised net injections in the past two weeks (54bn yuan this week and 74bn yuan last week) in order to offset the increase in the reserve requirement rate and lessen the pressure to raise interest rates, conditions are still tight, while expectations of an interest rate increase in the short term are high. SHIBOR has again been spiking up, but this time without any major underlying cause, such as the increase caused by the ABC IPO in June, when 1-month rates reached over 4%. While interest rates are expected to increase, it may only be a small change as the PBOC may prefer to use reserve requirement rates and open market operations to reduce money supply.
The so-called quantitative tightening approach (or, anything but lifting interest rates) has been publicly voiced as preferable by Chinese monetary officials, since it avoids encouraging hot money inflows into the region generally.
Then again, according to RBC Emerging Markets Research, realised inflation is making it increasingly hard for China to avoid raising rates outright.
As the analysts noted on Friday:
In our view, such comments clearly indicate a growing sense of urgency in Beijing to normalize policy settings. As the chart below shows, Beijing was much more pro-active in increasing policy rates in response to rising inflation pressures back in 2007 and 2008. This time, in contrast, policy-makers have been reluctant to move due to persistent concerns about both the domestic and global growth outlook, and it seems increasingly apparent that they are paying the price for this reluctance – literally – in the form of uncomfortably high inflation. This should prompt more decisive action in the weeks and months ahead.
The lag between Chinese interest-rate hikes and inflation, meanwhile, is clearly illustrated here:
And, you can betcha, US QE2 will only add further pressure to that inflation problem for China.
Whether it will be enough to coax yuan appreciation from the Chinese, though — is another matter.
Related links:
Here comes the quantitative tightening… – FT Alphaville
Dick Bove on QE2 as a bank-less “financial war with China” – FT Alphaville
China’s two (terrible) T-bill auctions - FT Alphaville