China's RRR hike: beginning of a tightening cycleThe PBOC announced the first increase in the reserve requirement ratio (RRR) since June 2008. We view this as a milestone that ends the current expansionary monetary policy. This RRR increase of 0.5ppt is broadly in line with our forecast of monetary policy trajectory since October 2009, but is somewhat earlier than market expectations. This move should soak up liquidity of over RMB200bn. Going forward, we think the PBOC will likely raise the RRR by another 100bps in the remainder of this year, and will likely start the rate hike cycle from Q2. Although the PBOC did not explain this policy move, we think the obvious reasons are: (1) CPI inflation has been accelerating at a faster-than-expected pace in recent weeks. We expect December CPI inflation to reach 2%yoy, a 3.8ppt rise from July. Given the rapid increase in inflation, inflation expectation has also become a more serious challenge to monetary policy. (2) Bank lending surged to RMB600bn in the first week of January. This trend is worrying and prompted the PBOC to take earlier actions to deter the loan growth momentum. We expect more aggressive window guidance to goalong with the warning sent via this RRR hike. (3) FX reserve accumulation has been fast and led to growing liquidity and an increase in the excess reserve ratio. (4) The very sharp increase in yoy export growth, to 18% in December, also contributed to the confidence of the policy makers in external demand recovery, which helps reduce opposition to monetary tightening.We think the initial market impact of this RRR hike will be somewhat negative, especially on properties, banks, and commodities. Although the direct impact of a 0.5ppt rise in RRR on the real economy and banks' earnings is minimal, it will be viewed by many investors as the beginning of more impactful monetary tightening. We advise investors to stay cautious in the near term.