China's central bank surprised financial markets yesterday by raising short-term interest rates on the first day back from the Spring Festival holiday — a further sign of policy tightening as the economy shows signs of steadying.
While the increases were modest, they reinforced views that China's authorities are intent on containing capital outflows and reining in risks to the financial system created by years of debt-fueled stimulus.
Higher interest rates could prod debt-laden firms into de-leveraging, though at the risk of stunting growth.
"It appears to be an intent to control a real estate bubble. It could also be aimed at arresting the yuan's depreciation, although it is on the reverse repo they touched upon and the impact remains to be seen," said Naoto Saito, chief economic researcher at the Daiwa Institute of Research in Tokyo.
"All in all, it comes across as a move to tweak interest rate levels to accompany a broader monetary policy shift."
The People's Bank of China raised the interest rate on open market operation reverse repurchase agreements (repos) by 10 basis points, effective yesterday. It also raised the lending rates on its standing lending facility (SLF) short-term loans.
The bank's Assistant Governor Zhang Xiaohui said later that monetary policy will be kept generally prudent and stable, while also avoiding either a rapid slowdown in economic growth or excessive liquidity injections.
Zhang also said China will keep the yuan basically stable and avoid large volatility in interest rates and foreign exchange rates. The comments were made in an essay published on WeChat by China Finance, a magazine affiliated with the central bank.
Analysts said the tightening of primarily money market rates suggested the bank wanted to retain policy flexibility as it balances the need to keep the economy from slowing again.
Other moves in recent months have signalled that China is eyeing a gradual shift from its loose policy stance.
In late January, the bank raised rates on its medium-term loan facility for the first time since it debuted the liquidity tool in 2014. It was the first time it had raised one of its policy interest rates since July 2011.
Analysts expect any further steps to be gradual as policy-makers weigh their impact on economic growth, and believe the bank will be in no hurry to raise the policy lending rate for now.
The one-year policy lending rate was last cut in October 2015 to 4.35 percent.
"China's economic recovery is still shaky, while the global economic situation is unstable, so raising open market rates is more appropriate than raising benchmark rates," said Li Huiyong, chief economist at Shenwan Hongyuan Securities.
"It's a flexible tool, which can be easily reversed if China's economy shows signs of weakness again."
The world's second-largest economy grew 6.7 percent last year — roughly in the middle of the government's target range.
Asian stock markets extended modest early losses after the rate rise, while China bond futures fell as much as 1.5 percent at one point. Most Chinese and global metal prices also fell on fears that higher rates will sap demand.
The central bank raised the seven-day open market operations rate — its unofficial policy rate — to 2.35 percent from 2.25 percent, while also lifting rates for SLF loans. The SLF rate acts as a de facto ceiling for interbank lending, analysts said.
The central bank also injected funds through seven-day, 14-day and 28-day repos yesterday, although there was a net drain of funds for the day owing to maturing open market operations.