By Winni Zhou and Elias Glenn

 

SHANGHAI/BEIJING (Reuters) - China's central bank will probably have to respond to an expected U.S. interest rate rise at a particularly sensitive time later this month.

 

Zhou Xiaochuan, the long-serving People's Bank of China (PBOC) governor, is widely expected to be replaced during the annual meeting of China's parliament, which started in Beijing on Monday.

 

The U.S. Federal Reserve's rate decision will be made public on March 21, a day after parliament is slated to end, leaving Zhou's successor a weighty first assignment.

 

That successor may be Liu He, a trusted confidant of President Xi Jinping. He has emerged as the front runner to take over, Reuters reported on Feb. 23.

In 2017, the Fed raised borrowing costs three times and the PBOC followed it twice - in March and December - tapping open market operations' (OMO) rates higher by 10 basis points (bps) and 5 bps, respectively. Economists say they expect a similar move by the PBOC this time around.

The Chinese market rates are already high relative to regional peers and other major economies, and the government's deleveraging policies have further tightened financial conditions. Yet, policymakers have been keen to show that China is in step with the global economy and to keep expectations consistent.

"Chances are good that the PBOC will hike along with a Fed hike but in a much more gradual way," said Zhao Yang, chief China economist at Nomura International in Hong Kong.

Few expect an increase in the official benchmark interest rates - one-year lending and deposit rates - which have been steady since 2015.

However, most believe the PBOC will make small adjustments to the rates it charges for short- and medium-term OMO loans, including 7-day reverse repurchase agreements. Participants in the money market consider the 7-day reverse repo rate as an unofficial benchmark for interbank interest rates, and say they expect that any changes to interbank borrowing costs will gradually translate to the broad economy.

"A gradual but small move timed along with the U.S. Fed (such as in Dec 2017) may help anchor market expectation and reduce market volatilities," Bank of America Merrill Lynch analysts in Hong Kong wrote in a note, adding that they expected a 5 bps increase in OMO rates in March.

POWERFUL ROLE

Liu, a U.S.-trained economist, is also expected to become a vice premier in charge of economic and financial issues. If he gets that and the central bank job he will become one of modern China's most powerful economic officials ever.

Zhao of Nomura said he did not think the change of the governor would affect decisions in the current rate cycle.

The PBOC lacks the independence of institutions like the Fed and needs cabinet approval to change benchmark interest rates or the value of the yuan currency. Market rate changes may not be subject to a green light from cabinet.

"Speaking from a global perspective, China is ahead of other central banks raising interest rates, as Chinese 10-year treasury yields hit 4 percent at one point," said Nie Wen, economist at Hwabao Trust in Shanghai.

"The PBOC would still likely follow the Fed with a rate hike, but a smaller move this time, around 5 to 10 bps, with a strong symbolic meaning," he added.

Recently, the PBOC has raised rates on days when it has rolled over a type of medium-term loan known as a medium-term lending facility (MLF) that it makes to banks.

Two batches of MLFs are due in the coming days - on March 7 and March 16 - but analysts say the PBOC is unlikely to take action on those days because they are ahead of the Fed's expected move and in the middle of the parliament session.

Nie expects the PBOC to add a cumulative 25 bps to market rates this year, or possibly as much as 50 bps if consumer inflation in China rises above 3 percent this year.

Some economists, however, see no need for China to increase rates in March because Beijing's deleveraging campaign has already tightened financial conditions.

"The room to tighten further is really limited as we expect the economy is going to slow this year," said Claire Huang, economist at Societe General in Hong Kong.

"The PBOC actually doesn't want to raise rates too much. Most of the tightening comes from financial regulations... Tightening from regulations is already enough."

Also on the horizon this month is a quarterly health check for financial institutions, conducted by the PBOC, which may impinge upon liquidity.

(Reporting by Winni Zhou SHANGHAI and Elias Glenn in BEIJING; Editing by John Ruwitch and Martin Howell)