SHFE Market Movement on May 04th, 2010 (Tuesday)

SHANGHAI, May 4 (SMM)&nbsp;-- The People's Bank of China (PBOC), the central bank, announced to raise the deposit reserve requirement ratio (RRR) for the third time this year by half a percentage point from May 10. SMM believes negative impact on base metals market will expand following China's third rise in deposit ratio.
1) Central Government's Further Steps to Tighten Monetary Policy 
On May 2, the PBOC said in a statement on its website that it would raise the deposit reserve requirement ratio (RRR) for financial institutions by half a percentage point from May 10. After the adjustment, the RRR for large financial institutions will rise to 17%, while the ratio for the rural credit cooperatives and rural banks would remain unchanged at 13.5%. This is the third rise in the deposit ratio so far this year. China's central bank lifted the deposit ratio on January 18th and February 25th by half a percentage point each time. During April 26t and 30, China absorbed a total number of RMB 115 billion cash, and this is the tenth consecutive week for the central bank to drain cash liquidity. In April, China totally drained RMB 437 billion in liquidity, marking the second consecutive month for cash liquidity collection since Chinese New Year holiday. In March, China totally absorbed RMB 602 billion, setting the second consecutive month for cash liquidity absorption through open market operations. The central bank drained over RMB 1 trillion in liquidity during the two months, suggesting China's central bank preferred to absorb cash liquidity in a mild way amid the relatively easing monetary policy, and it also signaled that the central bank's stronger confidence in domestic economic recovery.&nbsp;
2) To Rein in Economy 
SMM believes the Central Government aims to achieve the following two targets by raising the RRR. First, China's GPD was strong in 1Q, and domestic economic growth will keep a rapid growth if not reducing cash flow, and this will result in an overheating economic growth. According to the National Bureau of Statistics (NBS), China's GDP was as high as 11.9% in 1Q, leading to higher expectations of inflations. China's CPI was near the inflation target of 3% set for 2010 for several months. During 1Q, CPI was up 2.2% on a yearly basis. Of those, CPI in March was up 2.4% YoY; China's PPI in 1Q grew 5.2% YoY, and PPI in March was up 5.9% YoY, and up 0.5% MoM. The high CPI and PPI highlight strong pressure to ease inflations. Second, China's property market is still on the increase, especially during the seasonal peak sales period of May and June. If the Central Government doesn't take any necessary steps to curb cash supply, property prices in major cities will be at risk of losing controlling. Hence, it is a normal move by China's Central Government to rein in liquidity by lifting the deposit ratio.&nbsp; 
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3) SHFE Base Metals Market to Face Downward Pressure 
SMM believes the increase in the deposit ratio is expected to exert great negative impact on the financial and base metals markets. The higher required reserve ratio will curb cash liquidity, and credit lending as well, and the tightening monetary supply will significantly affect futures market. According to SMM data, SHFE 3-month copper prices plunged RMB 1,900/mt on the first trading day after China raised the required reserve ratio on January 13, and SHFE 3-month aluminum prices dropped RMB 845/mt, and SHFE zinc prices slid RMB 1,040/mt. The increase in the deposit ratio from May 10 is China's third rise in the reserve requirements, but the ratio is still away from its historic high of 23%, leaving a room to rise further, and this will negatively affect capital market in the short term. Meanwhile, equities and commodity markets will face great downward pressure, and SMM predicts SHFE copper prices will likely drop near to RMB 57,000/mt.&nbsp;
However, the rising deposit ratio will greatly reduces market expectations of higher interest rates, which will have a positive impact on the market. China will not increase interest rates until 2H 2010, if the impact from rising required reserve ratio is as positive as expected. In this context, base metals markets will likely rebound in the future following the absorption of negative news.&nbsp;
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