China's central bank on Tuesday decided to increase the reserve requirement rate for banks for the sixth time this year to tame the stubbornly high inflation, that climbed to a 34-month high in May.

The People's Bank of China announced on its website that the reserve ratio was raised by 0.5 percentage points, effective June 20. The ratio for the large banks will now rise to 21.5 percent. On May 12, the reserve rate was hiked by 50 basis points to 21 percent.

Official data released today showed that inflation climbed to a 34-month high of 5.5 percent in May from 5.3 percent in April.

Higher reserve requirement will help mop up excess liquidity from the financial system, thus moderating inflationary pressures. China hiked the interest rate four times in October last year, but a slowing growth is limiting scope for more policy tightening.

The International Monetary Fund in a report last week recommended China to rely more on interest rates while making less use of direct administrative limits on loan growth to achieve the policy objectives more effectively.

The IMF said inflation will soon peak and may ease to around 4 percent by the end of the year. It also pointed to upside risks from higher global commodity prices or weather related food supply shocks in China. In its latest economic outlook report published last month, the Organization for Economic Co-operation and Development, or OECD, warned that if tightening is insufficient, inflationary pressures are likely to build further, ultimately necessitating strong further policy actions and raising the risk of a much deeper slowdown in the medium term.

The policymakers are caught in a double bind with rising inflation on one hand and signs of slowdown in growth on the other. The Chinese economy expanded 9.7 percent year-on-year in the first quarter, slower than 9.8 percent growth in the fourth quarter of 2010.

The IMF forecasts that China will grow by 9.5 percent each in 2011 and 2012, while the OECD sees 9 percent growth for the economy this year.

RTTNews