China c.bank could cut FX reserve ratio to ease dollar funding strains

SHANGHAI, March 10 (Reuters) - China's central bank could cut the amount of foreign exchange reserves that banks must hold to ease dollar funding strains, analysts said on Friday, as expectations of aggressive hikes in U.S. interest rates worsened liquidity conditions.

Hawkish comments from U.S. Federal Reserve Chair Jerome Powell suggested U.S. interest rates could go higher for longer, prompting global funds to pile into dollar-denominated assets.

"Market attention should be on tight onshore dollar liquidity," analysts at ANZ said in a .

"In this case, a cut in the reserve requirement ratio (RRR) for foreign currencies will be more likely than (for) the yuan in the term."

The overnight dollar borrowing cost in the onshore interbank market USDONLWA=CFXS is trading at a premium of 10 basis points to the SOFR USDSOFR=, a Libor replacement preferred by the Fed, having risen above it since February.

"It is to cut FX RRR to ease the tensions," said a trader at a Chinese bank.

Tighter yuan liquidity exacerbated the situation, according to Industrial and Commercial Bank of China (ICBC).

"In order to fulfil the yuan demand, some institutions chose to use FX swap tools to acquire local currency liquidity," ICBC said in a post published on China FX trade system's (CFETS) official WeChat account.

The widening yield gap between China and the United States encouraged market participants to swap -end dollars for yuan at a lower cost.

The dollar/yuan swap curve 0#CNYCSWP=CFXS stayed in territory, with the one-year rate CNY1Y=CFXS hitting a 2-1/2-month low of -2,167 points on Thursday.

China's central bank made its biggest weekly cash withdrawal in more than two months this week, with some investors expecting a reduction to banks' reserve requirements soon.

Separately, a cut to the FX RRR could relieve yuan depreciation pressure, as the local currency CNY=CFXS traded far from the psychologically critical 7-per-dollar level. CNY/

The PBOC previously adjusted the FX RRR in September to rein in a sliding yuan and make it less expensive for banks to hold dollars.

(Reporting by Winni Zhou and Brenda Goh; Editing by Simon Cameron-Moore)

((winni.zhou@thomsonreuters.com; +86 21 2083 0100; Reuters Messaging: winni.zhou.thomsonreuters.com@reuters.))