China intensifies battle against bubble

The PBoC raises its key policy rates for the first time since December 2007.

China last night surprised the global markets by hiking interest rates for the first time in three years, signaling worries over the fast growing inflation and unreasonably high asset prices in the mainland.

The People's Bank of China (PBoC) said yesterday evening it will raise the one-year renminbi lending rate by 25 basis points to 5.56% from 5.31%, and the one-year deposit rate by the same amount to 2.5% from 2.25%, effective today. This is the first time that the PBoC has raised its key policy rates since December 2007, but the move follows three 50bp increases in the reserve requirement ratio (RRR) earlier this year, as well as a targeted RRR hike for six major banks last week.

The announcement came as a surprise as most market observers expected the PBoC would only lift interest rates next year, and Chinese policy makers have also been reiterating that inflation, while stubborn, is well under control and that the nation can easily keep it below its consumer price index (CPI) target. Only last week, senior PBoC officials were quoted saying that a rate hike during the rest of this year was unlikely.

China set an inflation target of 3% early this year, but real consumer prices don't look as good as the official data.

“The interest rate hike comes much earlier than we expected, we all thought it wouldn't happen until sometime next year," said May Yan, a Chinese banking analyst at Barclays Capital. "It suggests the economic data due to be announced on Thursday won't be favourable and that the inflation figures will be fairly high.”

The Chinese government is due to report its third-quarter gross domestic product figure and other economic data on Thursday (October 21). “It originally planned to announce the figures by October 11 to 15 but the government decided to postpone the date possibly because of the worse-than-expected data,” Yan said.

The CPI increased to 3.5% in August, the highest in 22 months and up from a 3.3% annual rate in July, according to China's National Bureau of Statistics. Compared with the one-year yuan deposit rate of 2.25%, this resulted in a real interest rate below zero, which means that Rmb10,000 deposited in the bank last August only had the purchasing power of Rmb9,875 in August 2010.

“We would interpret the rate hike as a symbolic move by the central bank to manage inflation expectations, as the latest figures on headline CPI stay elevated, as well as the rally in property prices,” J.P. Morgan said in a report. The US bank expects China's September CPI to have risen at 3.5%.

The rate hike also “signals that Chinese policymakers have become more confident about the real economy, especially with regard to the strengthening momentum in domestic demand,” the bank added.

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