China raises bank reserves as cash inflows surge

BEIJING (Reuters) - China has increased required reserves for its biggest banks to mop up some of the cash that is streaming into the country and posing a growing inflationary threat.

Although Chinese officials have directed their ire at U.S. monetary easing as a cause of unwanted speculative inflows, data on Wednesday provided a reminder that a whopping trade surplus is the main source of Beijing's liquidity headache.

The central bank lifted the reserve requirement ratio for Bank of China <601988.SS> <3988.HK> and Bank of Communications <601328.SS> <3328.HK> by 50 basis points, three industry sources told Reuters. Chinese media said the increase also targeted the country's other main state-owned lenders.

The move means the biggest banks are setting aside a record 18 percent in reserves, BNP Paribas said in a note to clients.

Banking shares in China tumbled by 2 percent after the move, which could force lenders to put a total of about 180 billion yuan ($27 billion) on deposit with the central bank, preventing them from extending that money as credit.

The news also fueled expectations among global investors that Beijing might step up its monetary tightening to cool asset markets and prices with inflation on course to hit a two-year peak.

The Australian dollar, which is sensitive to Chinese demand, fell. European shares <.FTEU3> opened down and oil also weakened.

"China's economic growth is a bit too fast and the country faces high inflation risks," said Dong Xian'an, chief macroeconomist with Industrial Securities in Beijing. "The authorities will use monetary policies to strongly curb inflationary expectations."

The reserve requirement increase, which takes effect on November 15, follows a similar move in mid-October that is due to expire next month.

The central bank raised interest rates last month for the first time in nearly three years and some analysts believe another increase could be around the corner, with inflationary pressure on the rise.

INFLATION

Annual consumer inflation rose in September to a 23-month high of 3.6 percent and analysts polled by Reuters expect data on Thursday to show that it climbed in October to 4 percent, a two-year high.

But there was market talk that the number could be even higher than expected, reaching as much as 4.5 percent.

"Inflation could get out of hand if we don't take any actions right now," said Wang Jun, economist at CCIEE, a government think tank in Beijing.

Zhou Wangjun, deputy head of the price department at the National Development and Reform Commission, a powerful central planning agency, said that inflation would remain strong in October and November before slowing in December.

Zhou pointed his finger at liquidity, not supply problems, as the cause of the price pressures, and expressed confidence that Beijing would be able to wrest inflation under control.

Chinese officials have raised concern that the Federal Reserve's decision to pump $600 billion into the U.S. economy would lead to capital inflows hitting emerging markets, reflecting global tensions over economic rebalancing on the agenda of a Group of 20 summit in Seoul.

TRADE TROUBLE

Despite the worries about speculators, a rebound in China's trade surplus in October highlighted how most of the cash rushing into the country is coming via more ordinary channels.

The surplus jumped to $27.1 billion, up from $16.9 billion in September and also higher than expected.

"They (the data) showed an outlook for strong economic growth, and I think the Chinese government will have more confidence to further tighten its monetary stance," said Eliza Liu, an economist with CCB International in Beijing.

Although some analysts forecast that the surplus would narrow in coming months, the impressive trade performance in October came at a politically awkward time for Beijing, lending fresh ammunition to foreign critics of the country's currency policy ahead of the G20 summit starting on Thursday.

"It might be a bit embarrassing for the Chinese government," said David Cohen, economist with Action Economics in Singapore.

The yuan rose against the dollar on Wednesday to its highest level since the currency's landmark revaluation in July 2005. Some said Beijing was sending a message to G20 about its willingness to push through more appreciation.

Chinese officials have shown concern at the rise in capital inflows. On Tuesday, regulators announced new rules to curb hot money flows.

The central bank also raised the yield on one-year bills at an auction on Tuesday to draw cash from the market, which some analysts saw as a sign that policy action would follow.

"China still has a strong momentum of rapid credit expansion," Du Jinfu, a deputy governor at the central bank, said on Tuesday.

"There is obviously an increase in cyclical macro-economic risks such as excessive liquidity, inflation, bad debts and asset bubbles," Du told a financial conference.

($1=6.64 yuan)

(Reporting by Beijing and Shanghai Economics team; Writing by Simon Rabinovitch; Editing by Ken Will and Neil Fullick)