UPDATE 1-China c.bank raises bill yield, steps up tightening

By Zhong Hua and Karen Yeung

SHANGHAI, Jan 19 (Reuters) - China's central bank signalled in its open market operation on Tuesday that its quantitative tightening was still intact but it aims to shift fund drains to longer-term tenors to rein in lending and fight inflation.

The People's Bank of China (PBOC) auctioned 24 billion yuan ($3.5 billion) of one-year bills at a yield of 1.9264 percent, traders said, above market forecasts of 1.84 to 1.89 percent and up 8 basis points from last week's level.

China has rattled financial markets by moving faster than expected to tighten its grip on liquidity as a strong recovery and rising asset prices threaten to cause overheating in the world's third-largest economy.

Last week, the central bank raised bank reserve requirements after reports that bank lending surged in the first week of the year to 600 billion yuan, adding to concerns fuelled by blockbuster trade data for December.

Some traders previously thought the PBOC may pause in its quantitative tightening campaign after it unexpectedly sold three-month bills at 1.3684 percent last Thursday, unchanged from the previous week.

But traders said Tuesday's one-year bill result showed that the PBOC wants to increase the attractiveness of one-year bills, which are more effective in locking up funds for a longer period than through three-month bills and short-term bond repurchase agreements.

'The central bank wants to lock up funds for a longer period because of concerns of the risk in inflation in the longer term,' said a trader at a major Chinese bank in Shanghai.

Shanghai's share market trimmed earlier gains after news of the central bank's one-year bill sale. The index initially rose nearly 1 percent in early trade but ended the morning with a rise of only 0.27 percent as it sparked renewed worries over a stepping up of monetary tightening, traders said.

Yi Gang, vice governor of the PBOC, said on Tuesday that China still needed to stick to its moderately loose monetary policy in 2010, although it added that China would make monetary policies more flexible and targetted.

But Societe Generale said in a research note in the wake of Tuesday's auction that the central bank's wording of 'flexible and targetted' was currently still tightening.

'The hike in the reserve requirement and the draining of liquidity while in fashion with the notion of flexibility and targetting, cannot be dismissed as anything other than tightening no matter how minor at this stage,' SG said.

In the previous one-year bill sale, the yield came in at 1.8434 percent, when the bank allowed a bigger-than-expected rise of 8 bps, after keeping the yield flat since mid-August.

But the fact that the auction yield remains well below the secondary market yield of the same tenor, suggests that the auction yield level is still unacceptably low. Traders expect the auction yield to rise to at least 2 percent in coming weeks.

In response to the auction, bill yields of around one-year were quoted up by as much as 4 to 5 basis points. The one-year central bank bill yield in the secondary market was indicated at 2.0360 percent bid on Monday, according to Reuters Reference Rates.



FUND DRAIN

The PBOC will not drain funds from the market on Tuesday through short-term bond repurchase agreements, traders said.

The decision does not reflect a change in the PBOC's policy to step up quantitative tightening, but merely shows it wants to temporarily ensure sufficient funds ahead of the Lunar New Year, in mid-February, when many workers pull money out of the bank to spend on gifts or bring home to their families.

As 190 billion yuan in central bank bills and repos will mature this week, the central bank appears set to conduct a net drain this week including the latest bank reserve ratio hike, effective Monday, which absorbed about 300 billion yuan.

Last week, the central bank conducted a net drain of 102 billion yuan, the 14th straight week of net drains.

($1 = 6.82 yuan)

(Editing by Jacqueline Wong) ((If you have a query or comment on this story, send an email to [e-mail]) Keywords: CHINA OPENMARKET ([e-mail]; [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.