China Raises Rates for Fourth Time to Cool Inflation

From Bloomberg today:

China Raises Rates for Fourth Time to Cool Inflation (Update1)

By Nipa Piboontanasawat

Aug. 21 (Bloomberg) -- China raised interest rates for the fourth time since March to cool the world's fastest-growing major economy after inflation surged to a 10-year high.

The benchmark one-year lending rate will increase 0.18 percentage point to 7.02 percent tomorrow, the People's Bank of China said on its Web site. The one-year deposit rate will rise 0.27 percentage point to 3.6 percent.

China's economy grew at the fastest pace in more than 12 years in the second quarter on investment and exports. Consumer prices climbed 5.6 percent in July as the cost of food soared, while the central bank later cautioned that inflationary pressures were broadening.

``This is a reflection of the central bank's concern about inflation and asset bubbles,'' said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong. ``We can't rule out another interest rate hike this year.''

It's the second time this year that deposit rates increased more than lending rates. The government is trying to make bank savings more attractive to stem the flow of money into property and stock speculation and curb asset bubbles.

The increase is to control ``money supply and loans and stabilize inflation expectations,'' the central bank said.

`Bigger' Bubble

Inflation has outstripped returns on bank savings. The government reduced a tax on interest income last week to 5 percent from 20 percent to make deposits more attractive.

``This is targeted at slowing the money flowing into the stock market,'' said Liao Qun, chief economist at Citic Ka Wah Bank in Hong Kong. ``As the bubble gets bigger, the chance of it bursting is also bigger.''

The key CSI 300 Index has climbed 144 percent this year after more than doubling in 2006. Property prices have also surged. In July, housing prices jumped 19.4 percent from a year earlier in Shenzhen and 10.4 percent in Beijing.

Wang Qing, chief China economist at Morgan Stanley in Hong Kong, said the central bank may raise interest rates again in the fourth quarter.

China is easing controls on money leaving the country to reduce the build-up of cash in the financial system. Yesterday, the government said Chinese investors will be allowed to put money into Hong Kong stocks.

Trade Tension

A stronger yuan would also help to curb the inflow of money and reduce tension with trading partners including the U.S. The currency has gained 9 percent versus the dollar since a revaluation in July 2005. U.S. manufacturers say the yuan is kept weak to make China's products cheap.

Besides raising rates, the People's Bank of China has ordered lenders to set aside larger reserves on six occasions this year. It has also sold bills to soak up cash.

The top priority is to prevent the economy from overheating and keep prices tamed, the central bank said in a quarterly monetary-policy report released Aug. 8.

Consumer-price increases aren't solely the result of ``temporary factors,'' the People's Bank of China said then, highlighting energy and labor costs and people's expectations for inflation.

Economists are split on whether the acceleration in consumer prices is temporary and limited to food or ``getting out of control,'' a term used last month by Tao Dong, chief Asia economist at Credit Suisse Group in Hong Kong.

Non-food inflation slowed to 0.9 percent in July from at least 1 percent in each of the previous five months.

China's economy, the world's fourth largest, expanded 11.9 percent in the second quarter from a year earlier.

The trade surplus surged 67 percent in July from a year earlier to $24.4 billion, the second-highest monthly total. Money supply climbed 18.5 percent, the biggest increase in more than a year.

Fixed-asset investment in urban areas increased 26.6 percent in the first seven months from a year earlier, close to the 26.7 expansion in the first half.

Also the Financial Times:

Chinese central bank raises interest rates

By Reuters, August 21, 12.13 BST

China raised interest rates on Tuesday for the fourth time this year to stabilise inflation after consumer prices rose in July at the fastest pace in more than a decade.

The People’s Bank of China (PBOC) said it was raising the rate that banks pay for one-year deposits by 27 basis points, to 3.60 per cent, and the corresponding benchmark for lending rates by 18 basis points, to 7.02 per cent from 6.84 per cent.

The increases go into effect on Wednesday.

Although the timing was a surprise, the action itself was not despite turbulence in global markets that has prompted the Federal Reserve to cut its discount rate and hold out the prospect of a reduction in the federal funds rate.

Most economists had forecast an increase, both to anchor inflationary expectations and to reduce the incentive for savers to take their money out of the bank – where real deposit rates are deeply negative – and pile into the surging stock market.

”The PBOC is concerned about falling real deposit rates spurring the flow of funds out of deposits into equities. We don’t think this is a response to strong growth,” said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong.

Although the economy expanded 11.9 per cent in the second quarter from a year earlier, Lin Songli, an analyst with Guosen Securities in Beijing, agreed that, by raising lending rates less than deposit rates, the central bank was signalling it was not intending primarily to slow the pace of growth.

”The move is mainly targeting inflation, and the authorities might have reached a consensus that investment growth is not a big problem now,” Lin said.

Consumer prices surged 5.6 per cent in the year to July, the fastest pace since early 1997, because of a spike in the cost of pork, eggs and other foods.

Although non-food inflation fell to 0.9 per cent in July, policy makers are concerned that price increases are already rippling out across the economy.

”It’s also meant to curb fast growth in the stock market, which is now at historical highs and is rising very fast,” Lin said.

The main Shanghai share market is up 80 per cent this year on top of a 130 per cent leap in 2006.

Lin said bank shares were likely to fall hard on Wednesday in response to the rate rise.