China stocks, money markets freeze up on policy uncertainties

By Lu Jianxin and Pete Sweeney

SHANGHAI, May 27 (Reuters) - Growing uncertainty over China's monetary policy and economic health is keeping investors from making bets in the country's stock and money markets, sending volumes plunging.

Stocks slumped earlier this month after the People's Daily quoted an "authoritative person" as saying China may suffer a financial crisis if the government relies too much on debt-fuelled stimulus.

Some China watchers saw the warning as a sign of internal conflict at top policymaking levels, after recent data suggested that a pick-up in the economy in March may have been short-lived.

On Thursday the PBOC's monetary policy analysis team published an article saying it would keep policy "generally prudent with slight loosening," but investors remain wary.

Share trading volumes in Shanghai have shrunk to a near five-month low and action in money markets is tepid. The benchmark seven-day bond repurchase agreement contract has hovered around 2.3 percent since November.

"The market has been fluctuating within a tight range. We see no big improvement in economic fundamentals. There is no good news," said a liquidity trader at a bank in Shanghai.

Steven Leung, director at UOB Kay Hian in Hong Kong, predicted that stock markets in both China and Hong Kong would remain lacklustre until September, barring dramatic surprises in economic performance.

WHAT NEXT?

The major concern for investors is whether and how the PBOC will move to support economic growth without aggravating price bubbles that are already re-forming in real estate, commodities futures and even mundane items such as garlic.

Instead of reducing reserve requirement ratios (RRR) at banks - a move that would likely be applauded by stock investors as it would unleash billions of yuan currently locked up in bank reserves - the PBOC has grown cagey, relying on shorter-term targeted cash injections to keep specific banks cashed up without empowering speculators.

"The market has greatly reduced its expectations of an immediate RRR cut as it clearly feels that the PBOC is using new policy tools to replace it," said Dong Dezhi, chief fixed income analyst at Guosen Securities in Shanghai.

"Apparently, the central bank is hesitant to pump too much long-term liquidity into the banking system."

Likewise, some economists have dialed back expectations of several more interest rate cuts in 2016 after six reductions in less than a year.

The PBOC is believed to be concerned that more rate or RRR cuts could revive downward pressure on the yuan currency and capital outflows, which it finally managed to staunch earlier this year after a record drop in foreign exchange reserves.

That has eyes turning to the foreign exchange market, where the yuan has softened around 1.5 percent in May to 6.56 per dollar in anticipation of a U.S. Fed rate hike as early as June.

If that softening prompts fresh capital outflows, it might require the PBOC to resume cutting rates to offset the drain on the domestic money supply.

(Additional reporting by the Shanghai Newsroom; Editing by Kim Coghill)

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