From “China: CPI inflation below prior expectations, impact of basket adjustments not clear, further tightening still needed and likely” by Song Yu and Qiao Hong, Goldman Sachs, February 15
We believe further tightening measures are still needed given: 1) Despite the lower-than-expected CPI inflation reading which could be lower than otherwise, its sequential month-on-month annualized reading still remains elevated at above 5%. 2) Although the lifting of supply-side restrictions is likely to provide some relief to inflationary pressures, aggregate demand growth is becoming strong. Domestic demand probably has been boosted by the frontloading of lending since the start of the year, which probably led to a loosening of monetary conditions. Meanwhile, external demand growth has also been accelerating quickly in recent months, which adds additional pressure on aggregate demand growth. Although January exports data was clearly distorted by the Lunar New Year on the upside, the strength of the growth is such that we believe its underlying growth momentum is indeed very strong amid the recovery in global demand. 3) The recent drought in northern China may change people’s expectations about grain and food prices despite the fact that its actual impact on grain output might not be as large as many people have feared.
From “The Interest Rate Hike: You Can’t Beat the System!” by Carl B. Weinberg, High Frequency Economics chief economist, February 14
Up until a few years ago, the reserve ratio was a perfectly fine tool for forcing banks to cut back on their lending. However, the growth of the interbank lending market has added a new wrinkle to the funding patterns of banks. Whereas banks were previously entirely dependent upon People’s Bank of China (PBoC) reserve creation and foreign capital inflows for funding, the new reality is that they rely on the interbank market for marginal liquidity. As the interbank market has grown, we have seen interest rates for term interbank money rise whenever the PBoC squeezes the reserve ratio, as you might expect. The connection to monetary policy is that raising the reserve ratio nowadays can eradicate banks’ profits on marginal loans and shut down lending altogether. Short-term lending rates broke through 8% last month, as banks shut down interbank lending – they had no excess reserves to lend out – and retained whatever reserves they had received. This pushed funding costs for new loans over the administered official lending rate of 5.81%, which shuts down lending altogether. Interbank lending was invented only in 2006, and it has become important policy only in the last few years.
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