China on Sunday raised the proportion of deposits that lenders must keep in reserve at the central bank, another step in its months-old campaign to mop up excess cash in the economy at a time when inflation is on the rise.

The People's Bank of China said it was lifting lenders' reserve requirement ratio by 50 basis points, effective May 10, its third increase of that magnitude this year.

The move, which will drain about 300 billion yuan ($44 billion) of cash from the banking system, is bound to fuel speculation that officials are preparing for an influx of capital in anticipation of a long-awaited decision to let the yuan resume its climb, stalled since July 2008.

However, the two increases earlier this year were not linked to any change in currency policy and many economists have stressed that the central bank needs to raise reserve requirements regularly purely to keep a cap on liquidity.

We continue to believe a modest appreciation of the yuan is very likely, though this particular RRR hike does not necessarily add any new information on this front, Yu Song and Helen Qiao, economists at Goldman Sachs, said in a note to clients.

They said they expected a 5 percent in the yuan against the dollar over the next 12 months, repeated increases in required reserves and an interest rate rise around mid-year.

In contrast to regional neighbors such as India, Malaysia and Australia, China has so far eschewed the blunter instrument of higher borrowing costs, not least because it harbors doubts about the solidity of the global recovery and has an eye on the all-important property market.

Starting since March, quite serious price pressures have been flaring up again, Dong Xian'an, chief economist at Industrial Securities in Shanghai, said.

But because house prices have been falling in month-on-month terms, we think authorities will push back interest rate increases. Instead, it is very clear that the central bank prefers to use quantitative measures for its monetary controls, he said.

DON'T BLAME THE YUAN

Along with nudging up required reserves, which now stand at 17.0 percent for big lenders, Beijing has ordered banks to rein in their credit issuance and the central bank has stepped up its drainage of cash via open market operations.

Jun Ma, chief Greater China economist at Deutsche Bank, said the central bank was delaying a reckoning with the inevitable.

Noting that a survey of the country's manufacturing sector published on Saturday pointed to surging input prices, Ma said increases in required reserves and moral suasion by the central bank would very soon prove to be inadequate.

Within a few months, the government will have very few choices but to resort to rate hikes and some price controls, in our view, he said in a note to clients.

Underlining the government's view that Sunday's move is technical in nature, Finance Minister Xie Xuren said soon after the announcement that China was committed to maintaining the appropriately easy monetary policy that it adopted in late 2008 when the international financial crisis was raging.

Speaking in Tashkent during the annual meeting of the Asian Development Bank, Xie restated China's long-standing policy that it would hold the yuan basically steady at a reasonable level.

You really can't cite China's trade surplus as an excuse to ask China to let the yuan appreciate, Xie said.

RISKS LOOM

In practice, China has been gradually normalizing its monetary stance after it pumped an extraordinary flood of cash into the economy last year to power it through the global slump.

In the recent words of deputy central bank chief Hu Xiaolian, the policy emphasis is now on appropriately, not easy.

As ginger as the tightening has been, the impact on the stock market has been profound. The main Shanghai index has trended down in a tight range since August of last year.

The central bank announced the latest reserve ratio over a three-day holiday weekend, a move that may have been intended to help investors digest the news before markets reopen on Tuesday.

The statement, posted on the central bank's website, www.pbc.gov.cn, came more than a week before China is scheduled to issue inflation data for April. It reported modest consumer inflation of 2.4 percent in the year to March.

But Brian Jackson, a strategist with Royal Bank of Canada in Hong Kong, said house prices in particular were rising very fast.

The risk Beijing now faces is that the measured, targeted approach it has taken so far will not be enough to keep these price pressures under control, which would then force policymakers to tighten more aggressively later on.

To avoid this risk, we expect that Beijing's efforts to tighten policy will soon include higher benchmark rates and a stronger currency sometime in the next few months, he said.

(Additional reporting by Zhou Xin in Tashkent; Editing by Alan Wheatley, Mike Nesbit)

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