People's Bank of China Governor Zhou Xiaochuan said that the nation needs to take more measures to solve its problem of liquidity-driven inflation but warned that the bank should be cautious in hiking interest rates.

"Apart from soaking up excessive liquidity (through raising reserve requirement), we can also take measures to slow down the multiplication of money," he said, without elaborating on specific methods.

Zhou added that the government is taking a very prudent approach toward raising interest rates given the unstable and rapidly changing global economic situation.

But in the medium term, average deposit interest rates will be higher than the growth rate in CPI to ensure stable economic development.

China's move to increase holdings of US Treasury bonds is a reasonable choice based on the market situation and will probably continue for the next six or seven months, said analysts.

As the biggest buyer of US Treasury bonds, China has increased its holdings for the fourth straight month, purchasing about US$23.3 billion in October, according to the US Treasury Department on Wednesday.

China's holdings of US debt rose 2.6 percent over the period to US$906.8 billion, the highest level since November 2009.

Chen Daofu, policy research chief of the Financial Research Institute at the Development Research Center of the State Council, said the move was based on the recovery trend in the US economy and lower bond prices.

"This is a reasonable choice based on market fluctuations to better maintain the value of the country's foreign reserves," he said.

Recent US economic data on sales, investment, inventories and other aspects offered hints of a recovery to bond buyers, and the second round of quantitative easing is expected to boost US economic growth, said Li Wei, an economist with Standard Chartered Bank in China.

"What's more, the bond price showed declines and the dollar got stronger against the euro, making US debt purchases a natural choice," he said.

Foreign holdings of US Treasury bonds rose 1.1 percent to US$4.3 trillion, indicating their attractiveness to overseas investors.

About two-thirds of the total foreign holdings are held by overseas governments and central banks.

Japan, the second-largest holder, expanded its holdings to US$877.4 billion, a 1.5 percent rise from October, and third-ranked UK increased purchases by 4 percent to US$477.6 billion.

Although China's strategy of diversifying its US$2.45 trillion foreign exchange basket won't be altered, in the short-term US Treasury bonds remain a sound investment option for the country.

Chen said China would continue to adjust its holdings of US debt to ensure better yields, but it is hard to find any other investment channel that is good enough, especially when Europe is still weighed down by sovereign debt problems.

"Although European and emerging market debts are options for China, they cannot match the strength of US debt in foreign reserves in the short term," he said.

Treasury bonds of Asian countries such as Japan and South Korea are good choices but accelerating capital inflows and rising inflation in the area may trigger interest rate rises and tightening capital controls, which may cause losses for holders of their debt, said Li.

He predicted the government would continue to buy US Treasury bonds over the next six or seven months as the dollar remains stronger against the euro, and any prospect of interest rate hikes by the Fed remains far off.

(China Daily December 17, 2010)