By Lu Jianxin and Jacqueline Wong
SHANGHAI, Feb 9 (Reuters) - The People's Bank of China (PBOC) appears to be waiting for coordinated liquidity action from global central banks, possibly in late February, before moving to cut bank reserve requirements.
Beijing moved early to cut banks' reserve requirement ratio (RRR), the world's highest, in late November as its economy sagged under the weight of slowdowns in its key export markets.
But it is now treading a fine line in pursuing measured easing, baffling markets that had confidently predicted it would cut RRR before the Lunar New Year in late January.
A second Long Term Refinancing Operation (LTRO) by the European Central Bank (ECB) could flag the PBOC's first cut in RRR this year, which will infuse some liquidity into the domestic market and boost China's clout on the global stage.
The PBOC has defied market hopes since mid-December that it would shift toward easier monetary policy.
The delay has put a firm floor on China's money market rates and sent interest rate swaps higher even as recently tight liquidity conditions loosened up after a rush for funds hauled the key lending rate to its highest in seven months .
The government may wish to avoid the impression it is ready to relax policy, particularly at a time when some overseas investors are shorting China on potential risk of a hard-landing in the world's second-largest economy.
Interest rate swaps have turned sharply higher since late January and the seven-day repo rate, the benchmark, has stayed firmly above 3.5 percent.
Wrongfooted by the PBOC's inaction, analysts have rolled back their timeframe for potential RRR cuts, though they are seen as inevitable this year as capital inflows fall.
Acting jointly with major global economies, such as it did in late November, will give China credibility as a responsible member of the global economy, while leaving the impression that it is not in a hurry to ease policy to boost growth.
'Major global economies may join hands to boost liquidity again around the time of the second LTRO - a time that is most likely for the PBOC to cut RRR as well,' said Zhang Yongmin, fixed income analyst at Qilu Securities in Beijing.
'Such a cut will be more or less a gesture that China is responsible in helping the global economy while the government will also seem as if it is not in any urgency for overall monetary easing, at least for the first quarter.'
DEJA VU ALL OVER AGAIN
The PBOC cut RRR for the first time in three years on Nov. 30, the same day when six global central banks, including the U.S. Federal Reserve, announced coordinated action to enhance their capacity to provide liquidity support to the market.
The moves came ahead of the ECB's ultra-long 3-year tender LTRO, which pushed 489 billion euros ($648.12 billion) to markets in December.
Later this month, the ECB will offer a fresh batch of three-year loans, possibly double the size of the first batch, which could further boost banks' ability to lend, traders said.
The PBOC's RRR cut then sparked widespread hopes in mid-December -- a time when the money market started showing signs of tightness ahead of the Lunar New Year -- that the central bank would come to the market's rescue with another RRR cut.
At the peak of such expectations, the PBOC announced instead that it would inject cash via bond reverse repurchase agreements, dampening hopes of a bolder RRR reduction and signalling that November's cut may have been the result of global coordinated action rather than a monetary policy change.
China's benchmark five-year IRS has jumped 43 basis points since late January to trade around 3.35 percent on Thursday as the market has been forced to adjust expectations about potential monetary easing.
The PBOC used reverse repos to inject at least 352 billion yuan ($56 billion) into the money market right ahead of the week-long Lunar New Year holiday in late January.
While the amount is roughly equal to a 50-basis-point RRR cut, the reverse repos mature in 14 days. Thus all the cash injected via those repos has returned to the central bank while the holiday-driven market squeeze has also lifted.
This week the PBOC resumed open market operations, draining 26 billion yuan via repos on Tuesday and another 20 billion yuan on Thursday
The drains came after the weighted-average seven-day repo rate fell below 3.5 percent on Monday. Traders said the PBOC may be eyeing that level as a floor for the benchmark money market rate.
The rate rebounded to around 3.7 percent on Thursday.
Economic data appears to underscore why China's loosening campaign has not started as the market expects. China's big manufacturers started the year with an upturn in production in January, an official purchasing managers' index (PMI) showed.
However, the annual inflation rate accelerated to 4.5 percent in January, well ahead of market expectations and breaking a five-month trend of easing price pressures.
But while the market has now softened its expectations for an immediate RRR cut or monetary policy easing, most players have not changed their forecasts for the year.
'Unless there is a significant positive turnaround of China data especially on inflation, we see little fundamental reasons for the market to write off expectation of further easing in the coming months,' said Wee-Khoon Chong, a fixed income strategist at Societe Generale in Hong Kong.
'We maintain our expectation of four RRR cuts this year but postponing our call for next RRR cut to March from February.
'But this alone is not enough to halt the upside IRS move. Not now at least. We see potential underperformance of CNY IRS against EM Asia and USD IRS and the back of renewed concern over liquidity squeeze,' Chong said in a research note last week.
($1 = 0.7545 euros)($1=6.3 yuan)
(Graphics by Catherine Trevethan; Editing by Kim Coghill) Keywords: MARKETS CHINA/DEBT
(jianxin.lu@thomsonreuters.com)(86 21 6104 1792)(Reuters Messaging: jianxin.lu.thomsonreuters.com@reuters.net)
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