Stop press: interest rate rise

China raised interest rates for the third time this year today which underlines its policy preference to bring inflation under control even if/as economic growth eases. A number of economists also labelled it as a confident move and plumped for a soft, not hard, landing.

The 25 basis point increases in lending (to 6.56%) and deposit rates (to 3.5%) were announced after the local market had closed (and Europe was at lunch), come into effect tomorrow (Thursday 7 July).

HSBC, JPMorgan and Merrill Lynch said the increase may be the last this year as inflation moderates, most probably after clearing 6% in June (May’s CPI was at a 34 month high of 5.5%). Capital Economics, however, is looking for one more.

HSBC said that “China’s inflation battle is almost at an end. Already, there are signs that price pressures are coming off. Today’s rate hike may therefore have been the last in the cycle. In general, given that the authorities decided to raise rates also shows their confidence in the local economy. Worries over a hard landing on the Mainland are overblown”.

“Perhaps most interesting is that the benchmark rates for deposits of more than one year have been increased by more than 25 basis points ... while the increase in the benchmark rate for loans of longer duration was lower than for one-year loans” noted Capital Economics. “The goal is to encourage savers to keep their money in bank deposits rather than shifting to equities or property. At the same time, the People’s Bank is apparently concerned that continued lending rate increases could squeeze some longer-term borrowers”.

Credit Agricole’s take was: “the move will be seen as a sign of strength, with solid growth momentum allowing policymakers to raise rates – and in the end global markets should respond positively to such move aimed at controlling inflation”.

And finally, UBS said that China is unlikely to suffer a hard landing. May data show that the economy is maintaining momentum, with industrial production rising 13% and an acceleration in fixed asset investment. A Government plan to build millions of low cost homes may also sustain growth.

On 23 June, Premier Wen Jiabao said in his FT article that efforts to stem inflation have worked and that the pace of consumer price increases will slow. “The overall price level is within a controllable range and is expected to drop steadily”. And then, earlier this week, he added that stabilising prices remains the priority for the Chinese Government even though price pressures have been contained. “Some factors driving up prices have been controlled, but not eliminated”. Similarly, on Sunday, the PBOC added that China still faces “large” inflationary pressure and that it would maintain a “prudent” monetary policy.

Perhaps the money market rate on Tuesday provided a clue too. The seven day repurchase or ‘repo’ rate, which measures interbank funds availability, rose 201 basis points to 6.82% in morning trade (the largest rise since 15 June). Note, too, though that this rate had been as low as 4.74% last Friday (1 July); and in the week commencing 20 June it topped out at 9.20%.

“Those guys have been dead wrong for two years”
- Fabled investor, Jim Rogers on hedge funds shorting China