China's central bank raised borrowing costs as a stable economy and factory reflation give it scope to follow the Federal Reserve in tightening policy.

Hours after the Fed's quarter percentage-point move, the People's Bank of China increased the rates it charges in open-market operations and on its medium-term lending facility.

The central bank said markets expected higher borrowing costs and that open-market rate increases don't necessarily equate to interest-rate hikes, according to a statement. With the economy steady, inflation rising and real lending costs going down, financial institutions have strong incentives to expand credit, and housing prices have surged in some cities, it said.

“The PBOC is right to explain that this adjustment was in large part driven by market expectations,” said Andrew Polk, Beijing-based head of China research at Medley Global Advisors, which advises institutional investors. “Moving in line with the Fed also shows that China is still essentially importing U.S. monetary policy, despite increased capital controls over the past several months.”

The cost of seven-, 14- and 28-day reverse-repurchase agreements was raised 10 basis points each. That followed an increase in early February Seven-day reverse repos were offered at 2.45%, 14-day reverse repos at 2.6% and 28-day reverse repos at 2.75%. Cost of funds lent via MLF increased by 10 basis points, with 6-month and 1-year rates raised to 3.05% and 3.2%. MLF rates were also increased in late January

With the economy starting 2017 on a firmer footing, a relaxed PBOC Governor Zhou Xiaochuan last week said the interest-rate differential with the U.S. won't lead to persistent speculation and rates will respond to the domestic economy. Factory-gate prices have ended four years of deflation and are now climbing at the fastest pace since 2008, allowing him to switch his sights to reining in excessive leverage and surging home prices.

The onshore yuan strengthened the most in a month on an intra-day basis. Government debt also increased, with 10-year yields falling four basis points to 3.32%.

Higher open-market operation interest rates are mainly decided by the market, the PBOC said in a Q&A statement. More flexible interest rates can help deleveraging, curb bubbles and prevent risks, and market participants already had relatively strong expectations for higher open-market rates based on China's economic rebound and the Fed's rate hike, it said.

Li Keqiang announced this month a 2017 expansion target of around 6.5%, or higher if possible, a speed he said isn't low or easy to meet. China will fasten its “seat belt” and rein in risks as it pursues mid- to high-speed growth, the premier told a group of about 1,000 journalists at the Great Hall of the People on Wednesday.

“The PBOC will continue with incremental tightening in the interbank market this year,” said Cui Li, head of macro research at CCB International Holdings Ltd. in Hong Kong. “But the impact on the real economy is likely limited, as financial conditions are still quite accommodative and real borrowing costs by enterprises are still near a five-year low.”

The timing of the PBOC's actions will need to synchronize with other major central banks in the future, particularly the Fed, because China can't use administrative tools to manage capital flows forever, according to Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong.

“Today's action is a precautionary action for the stabilization of the RMB exchange rate,” Yeung said. “It provides a signal that China will start to make use of interest rate tools to govern its monetary policy and influence cross border flows.”

Across the East China Sea, the Bank of Japan kept its unprecedented monetary easing program unchanged on Thursday.

The PBOC said in its statement there's no need to overinterpret its monetary actions. Some economists also cautioned against reading too much into the announcements.

“It's not a big move, and it won't have a major economic impact, but the message is financial sector derisking,” said Tim Condon, head of Asian research at ING Groep NV. “They believe this signal will discourage that kind of borrowing for more borrowing.”

Instant Insights /

China's Central Bank Raises Borrowing Costs

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