The People’s Bank of China Strikes Again!

You’ve got to hand it to the People’s Bank of China (PBoC) – it knows how to keep market players on their toes.

Just after the release of Chinese data last Tuesday, the PBoC surprised markets by raising the reserve requirement ratio (RRR) by another 0.50%, bringing the rate to a record high of 21.5% of Chinese banks’ reserves.

Even though its decision was unannounced, I can’t say it was unexpected. Sure, the PBoC’s RRR decisions aren’t marked on any economic calendars, but they might as well be. After all, the PBoC has raised the RRR every month this year so far. And judging by the upbeat figures China put up, Tuesday was as good a time as any to make the big announcement to tighten its monetary policy further.

First of all, fixed asset investment is now up 25.8% from the start of the year, which is a nice follow up to the 25.4% increase from January to April. This just goes to show that China is definitely not being stingy when it comes to investing for the future.

Secondly, China has been able to maintain a solid pace of growth in industrial production. Yeah, the 13.3% year-on-year rise in May is a tad bit softer than April’s 13.4% uptick, but by no means is it a weak figure. Remember, it’s still above the 13.1% increase that markets were anticipating.

Most importantly, inflation hit 5.5% last month, its highest level since Heath Ledger scared the heebie-jeebies out of us in The Dark Knight 34 months ago!

Inflation has been hovering above the PBoC’s target of 4.0% since November 2010, which is why the central bank has been so active in tightening its policy as of late.

PBoC Tight on Money

I suppose the question we should all ask now is, “Will this be followed by an increase in interest rates?”

Keep in mind, the PBoC does have a tendency to hit inflation with a one-two punch by following up RRR hikes with interest rate hikes.

Now, it hasn’t raised rates since April, which has allowed inflation to rise unchecked, but don’t count on this to go on for much longer.

“Check yo’ self before you wreck yo’ self,” is a rule that China sticks to when it comes to inflation, which is why many see interest rates rising by another 1.00% by the end of the year.

But don’t make the mistake of thinking that tightening policy has been or will be easy for the PBoC! Though the central bank has already jacked up interest rates left and right in the past few of months, its decisions are not without its downsides.

We’re already seeing these rate hikes take effect on the economy, just not so much on inflation. Word around the fx-hood is that lending is starting to turn down and China’s money supply dipped slightly in April as a result of tighter policy.

It’s a very difficult task trying to temper inflation without choking off growth. It’s sort of like eating tubs and tubs of ice cream and expecting not to gain weight… you can’t have it all!

In the past, increases in the RRR were met with bearishness for the comdolls. After all, they present risks to China’s growth, and therefore, risks to global growth. But that certainly wasn’t the case this week!

Rather than tumble, we saw the comdolls rally after the announcement was made, probably because the RRR increase was accompanied by the upbeat reports from China. But you still have to keep close tabs on these high-yielding currencies because chances are they’ll head south again once the PBoC officially raises its interest rate in the near future.