China raises rates on inflation fears



-- With China celebrating the New Year, central bank officials had to break into their holiday to consider changing interest rates. But it cannot have taken them long to decide on an increase.

After two increases late last year, many economists thought it was only a matter of time before the People's Bank of China delivered another rise in an attempt to tackle inflation with rising food prices a particular concern. On Tuesday it said it would lift rates for one-year deposits and one-year loans 25 basis points to 3 per cent and 6.06 per cent respectively.

Financial markets took the news in their stride. Copper, where Chinese buying is a big demand driver, slipped slightly before recovering most of the lost ground and trading at $9,974 a tonne for three-month metal, down from $10,045 on Monday.

A ripple of concern passed through emerging markets, where inflation is a concern, with an average fall of 1.2 per cent on east European stock markets.

"Most people expected a rate increase around now," said Mark Williams, a China specialist at Capital Economics, the UK-based research company.

Most economists expect a further 25 basis point rise in future. With inflation expected to rise from 4.6 per cent year-on-year in December to about 5-6 per cent, real interest rates remain in negative territory. So incentives remain to spend savings and borrow -- notably to invest in the fast-growing property market.

However, the Chinese authorities have been cautious about raising rates amid concerns the economy could be held back at a time when China is contributing greatly to global growth. The country saw GDP rise about 10 per cent in 2010.

They are also keen not to put extra upward pressure on the currency for fear of hurting exports. But Beijing is concerned about soaring property prices, which if unchecked could destabilise the economy and trigger social discontent.

As well as raising rates, the central bank has increased the ratio of deposits banks must place in reserve with the central bank. Following eight increases, the reserve ratio has gone from 15.5 per cent to 19.5 per cent in a year and is expected to go further, perhaps to 22 per cent.

But what matters is the actual impact on loans, which have been growing faster than the central bank intended, with a jump last year of Rmb7,950bn ($1,215bn) in new loans, compared to the Rmb7,500bn target. With the official target for 2010 not yet set -- although it is expected to be about Rmb7,000bn-7,500bn -- it is unclear how tightly banks will be corralled.

China bulls contend that the authorities are by and large managing a huge job well -- controlling inflationary risks as much as they can without taking more than perhaps 1 percentage point off GDP growth. Mr Williams says: "I am not sure that the Chinese economy requires much more policy action. Growth has already cooled."

The bears disagree, arguing inflation is taking root. Companies are under pressure from rising costs, which are hitting margins and undermining export competitiveness.

Charles Dumas, chairman of Lombard Street Financial, a research company, says: "The policy actions amount to too little too late." The level of rate rises needed to control inflation will squeeze growth hard, he says. "They are between a rock and a hard place."

Even at this stage, some of the price pressure could be reduced by faster currency appreciation. But Chinese exporters are a strong lobby. They will not give ground easily.