China Might Tighten Monetary Policy After Key Meeting In November

The author is Nomura economist Zhiwei Zhang

The 7-day repo rate rose to 4% yesterday from around 3.6% the day before and continued to rise to above 5.5% earlier today.

We highlighted our expectation last week that monetary policy was about to be tightened. We do not believe that the current rise in the repo rate is being driven by seasonal factors such as the corporate tax payment season.

The Chinese government is well aware of such seasonal factors and could have adjusted its liquidity management accordingly to offset such factors and avoid rise of the repo rate, yet it has allowed repo rates to rise, which we take as a clear policy signal.

We believe policy tightening is well justified, as growth rebounded in Q3 and CPI inflation surprised on the upside in September at 3.1%.

We expect inflation to rise to 3.5% in October, adding more pressure on the People’s Bank of China to tighten policy.

We reiterate our view that the economic recovery is unsustainable as the government will tighten policy to address inflation, financial systemic risks and the pollution problem that has again made global headlines.

We do not expect a repeat of the liquidity squeeze seen in June as we believe the government learned from that episode to manage the liquidity risks properly.

Moreover, we believe a repeat liquidity squeeze is politically unfeasible ahead of the important Communist Party meeting in November.

We expect policy tightening to be done in a gradual and controlled manner, possibly picking up speed after the November meeting if inflation continues to surprise on the upside.

(The article has been edited for clarity)

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