Sunday, January 30, 2011

PBOC's Decision to Use Currency Swaps next Month Could Signal Benchmark Interest Rates Will Go Higher; Inflation Poses Intricate and Sensitive Problems ..

BEIJING (Dow Jones)--China's central bank said Sunday it aims to keep interest rates appropriate and handle liquidity properly in a bid to stabilize price increases, while also for the first time praising the yuan exchange rate reform carried out since mid-last year as having had a positive impact on the real economy.

The comments made by the People's Bank of China in its fourth-quarter monetary policy indicate Beijing's dedication to use all kinds of policy tools, including possible rate increases and faster yuan appreciation, to curb inflation, although it didn't elaborate on its plans on further reforming interest and exchange rates.

The report came after PBOC Governor Zhou Xiaochuan warned earlier Sunday that the central bank must be vigilant on inflation and may need to tighten reserve requirements further to address rapid capital inflows.

Speaking to Dow Jones Newswires on the sidelines of meetings in Kyoto, Zhou said Chinese price growth slowed slightly in December, though stronger than many had forecast, and signalled it had more room to climb.

"Inflation is still higher than many people expected. It may be still going up a little, so we should keep vigilant on that," Zhou said. Asked whether China needed to tighten banks' reserve requirements further to tackle rapid capital inflows, amid already excessive liquidity conditions, Zhou said: "Maybe we need to continue our efforts."

China's consumer price index rose 4.6% from a year earlier in December, down from 5.1% in November, which was the fastest rate in more than two years. Inflation has eaten into savings deposits at banks, as the one-year benchmark deposit rate stands at only 2.75%.

In 2010 overall, the CPI climbed 3.3%, above Beijing's official target of around 3%. The government has raised its target to 4% for 2011, tacitly acknowledging the limits of its ability to constrain prices.

The PBOC said in the report that it aims to "handle properly the liquidity and maintain reasonable and appropriate interest rate levels in a bid to create a sound monetary environment for stabilizing prices, managing inflation expectations and regulating the real estate market."

The PBOC didn't say what interest rate levels are deemed appropriate. But it pledged to "further promote the role of interest rates as a leverage in adjusting general demand and managing inflation."

The PBOC earlier this month raised China's reserve-requirement ratio for banks, following six such raises and two increases in benchmark interest rates last year. The government also raised the down payment for second-home purchases and launched trials on a real estate tax in Shanghai and Chongqing cities in a bid to cool the high property prices.

However, PBOC warned that potential risks for pushing prices up further can't be ignored, as developed nations are expected to keep super-loose monetary policies for the near term, while domestic labor costs and resources prices have kept rising.

The central bank reiterated it will further improve the yuan exchange rate mechanism and increase exchange-rate flexibility.

It also for the first time praised the reform since June 19 last year, when China pledged to increase its currency's trading flexibility and effectively ended a two-year-long peg to the U.S. dollar, as "having had generally positive impact on the real economy."

"The yuan exchange rate reform will have a greater impact on efforts to adjust the structure of China's foreign trade and its overall economy and to upgrade Chinese industry," the PBOC said.

It added that exporters' capability to cope with exchange-rate fluctuations has improved, but said it will further boost innovation on tools to manage exchange-rate risks.

As part of the efforts, China said Sunday it will allow banks to trade currency swaps for corporate clients from March 1, extending the use of the financial derivative beyond the interbank market in a move that facilitates corporate foreign hedging as Chinese trade continues to expand and cross-border investments accelerate.

The announcement comes as Beijing stepped up efforts to let the yuan be used more widely outside China as it aims to become less dependent on the dollar for trade and investment.

The PBOC monetary report expects this year's money supply growth at around 16%. But it said it needs to gauge liquidity by focusing more on the country's total financing, than simply looking at loan growth. It mentioned that other types of financing, such as trust loans and companies' bond and stock issuance, should be taken into consideration, too.

The PBOC reiterated it will follow a "prudent" monetary policy in 2011 and that such a stance helps prevent asset price bubbles and manage inflation expectations.

-Victoria Ruan contributed to this article, Dow Jones Newswires; 8610 8400 7799; victoria.ruan@dowjones.com

--Owen Fletcher, Natasha Brereton and Jean Yung also contributed to this article.

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(END) Dow Jones Newswires
January 30, 2011 09:16 ET (14:16 GMT)
Copyright (c) 2011 Dow Jones & Company, Inc.- - 09 16 AM EST 01-30-11
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