Aug. 24 (Bloomberg) -- Chinese lenders are paying record interest rates for government funds as rising yields on central bank bills fan speculation policy makers will further tighten supplies of cash.

The Finance Ministry received a rate of 6.5 percent for 30 billion yuan ($4.7 billion) of six-month money offered at an auction yesterday, the highest level in central bank data going back to December 2006. The People’s Bank of China raised rates on one-year bills last week for the first time since June, boosting the yield by eight basis points to 3.58 percent, compared with the 0.10 percent yield on 12-month U.S. Treasuries.

China has limited scope to stimulate the world’s second- biggest economy even as a faltering recovery in the U.S. and Europe’s sovereign debt crisis dim the outlook for global expansion. Inflation has exceeded Premier Wen Jiabao’s target every month this year and economic growth that’s double the pace of Brazil and Russia may give the government confidence to continue raising benchmark rates that have already been boosted by a total 75 basis points in 2011.

“Increases in the one-year bill yield have proved a good leading indicator of interest-rate hikes in China,” said Kevin Lai, a Hong Kong-based economist with Daiwa Capital Markets Ltd. “The turbulence in global markets has settled down and with inflation pressure still strong the central bank needs another rate increase to fully contain inflation expectations.”

Benchmark Rates

The central bank last raised its benchmark one-year lending and deposit rates on July 7, the third increase of 2011, after boosting yields at auctions of one-year bills in each of the two prior weeks. The yield was left unchanged at 3.58 percent at a 3 billion yuan sale of the securities yesterday. The one-year deposit rate is 3.50 percent, while inflation accelerated to a three-year high of 6.5 percent in July.

Yields on three-month and three-year bills also sold last week were eight basis points, or 0.08 percentage point, higher at 3.16 percent and 3.97 percent respectively.

China is unlikely to raise interest rates again this year, though two more increases are expected in 2012, said Lu Ting, an economist at Bank of America Merrill Lynch. Credit Suisse Group AG and Morgan Stanley cut their 2011 estimates for global economic growth in the past week, while Citigroup Inc., Goldman Sachs Group Inc. and JPMorgan Chase & Co. reined in forecasts for U.S. expansion.

Reserve Requirements

“The global situation is getting worse and it doesn’t make sense for the central bank to raise rates at this point,” said Lu, who is based in Hong Kong. “But with inflation set to average 4 percent for a few years, deposit rates still need to go up by another 50 basis points.”

Chinese consumer-price gains are set to top 5 percent in 2011, the most in three years, according to estimates from Daiwa, Deutsche Bank AG and Mizuho Securities Asia Ltd. The country’s inflation rate is still slower than the 6.9 percent rate in Brazil, 9 percent in Russia and 9.2 percent in India.

The central bank has held off from raising banks’ reserve- requirement ratios since June 20, the longest pause since a series of nine increases began in November. The ratio for major lenders climbed 4.5 percentage points to a record 21.5 percent in that time, draining 3.3 trillion yuan from the banking system, according to Chang Jian, a Hong Kong-based economist with Barclays Capital.

The deteriorating outlook for the global economy is also reducing the availability of cash as overseas investors favor safer bets than emerging-market assets, according to Bank of America’s Lu.

Foreign Currency

“The financial problems in the U.S. and Europe are likely to mean some slowdown of inflows of dollars or other foreign currency into China so the supply of liquidity into the banking system will decline in the short term,” he said.

The 6.5 percent rate banks paid for six-month deposits of government cash at yesterday’s auction, compares with 5.5 percent at the last sale of similar-term funds in May.

China’s seven-day repurchase rate, a gauge of funding availability in the financial system, fell 75 basis points to 4.45 percent as of 12:35 p.m. in Shanghai, retreating from a four-week high, according to a weighted average compiled by the National Interbank Funding Center. It jumped 1.97 percentage points in the five days after the central bank’s bill yield was raised on Aug. 16 as funds were set aside to subscribe for a 5.5 billion yuan convertible bond sale by GD Power Development Co.

The one-year swap rate, or the fixed cost needed to receive the floating seven-day repurchase rate, fell five basis points today to 3.78 percent, according to data compiled by Bloomberg. Yesterday’s closing level was the highest in two weeks.

‘Cash Shortage’

Five-year credit-default swaps on China’s sovereign bonds rose four basis points yesterday to 117 basis points, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Increases suggest deteriorating perceptions of creditworthiness and declines show improvement.

The yuan strengthened 0.13 percent to 6.3888 per dollar today in Shanghai, according to the China Foreign Exchange Trade System. It’s gained 0.8 percent this month, the best performance among Asia’s 10 most-used currencies excluding the yen, and touched a 17-year high of 6.3820 on Aug. 16.

“Banks are expecting the cash shortage to extend,” said Liu Junyu, a bond analyst in Shenzhen at China Merchants Bank Co., the nation’s sixth-largest bank. “There is less capital available for banks, with capital inflows declining and bill redemptions shrinking.”

Speculative Capital

A total of 351 billion yuan of central bank bills and repurchase agreements will mature next month, compared with 352 billion yuan in August, and redemptions will decline to 298 billion yuan in October, according to Liu.

The central bank’s foreign-exchange purchases fell to 219.6 billion yuan in July from 277.3 billion in June, the lowest level since February, official figures show.

Net inflows of speculative capital dropped to around $18 billion in the second quarter from $85 billion in the first three months of 2011, Morgan Stanley estimated in a July 12 report. China had a net outflow of $5.8 billion in July, Guotai Junan Securities Co. analysts led by Jiang Chao estimated in an Aug. 22 report, reflecting “a sharp rebound in global risk aversion.”

--With assistance from Regina Tan in Beijing and Judy Chen in Shanghai. Editors: James Regan, Sandy Hendry

To contact the reporter on this story: Nerys Avery in Beijing at navery2@bloomberg.net

To contact the editors responsible for this story: Sandy Hendry at shendry@bloomberg.net; Paul Panckhurst at ppanckhurst@bloomberg.net

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