[T.S.R:16574] China Attacks Liquidity As War On Inflation Intensifies; More Rate Hikes Likely In 2011

China's surprise Christmas interest-rate hike could signal Beijing has lost faith in other measures to rein in the rapid credit growth fueling housing and food inflation, according to one analyst.

 

Efforts to cool the pace of credit expansion through higher reserve requirement ratios, bank-lending targets, lending restrictions and other methods are losing traction, Royal Bank of Canada strategist Brian Jackson said in a note following the People's Bank of China rate-hike announcement Saturday.

 

"Officials will need to put more emphasis on adjusting the price of credit — that is, interest rates — to keep policy at appropriate settings," Jackson said in the note. "The Christmas Day move suggests that Beijing is coming around to this view."  Jackson said overall credit conditions are little changed from 2009 levels, when the government encouraging rather than restricting credit, in an effort to support the economy in the wake of the financial crisis.

 

But China's increasingly sophisticated financial system is finding ways around administrative controls, with lending taking place via trust companies or gray accounting that disguises lending from official figures, Jackson said.  "The sharp increase in inflation over the last six months also shows that Beijing's efforts to slow down the economy this year have had only a limited impact," Jackson said.

 

The central bank on Saturday lifted its key lending and deposit rates by a quarter point each, its second such move in 10 weeks. The hike, effective Sunday, brought the one-year lending rate to 5.81% and the one deposit rate to 2.75%.

Wrestling with liquidity

Over the course of its attempt to cool the economy this year, the People's Bank of China lifted the ratio of reserves banks must set aside six times, cut the banking system's annual lending target to 7.5 trillion yuan, and restricted lending for purchases of second and third homes. In spite of these moves, consumer price inflation surged to a 28-month record high of 5.1% in November.

 

On Friday, the central bank's Deputy Gov. Hu Xiaolian had reiterated plans to bring China's overall monetary supply back to more normal levels next year, saying the move was necessary to contain inflation and curb asset bubbles. The People's Bank of China said earlier this year it would shift from a "moderately loose" to a "prudent" monetary policy, in order to nudge the economy toward a less-inflationary growth trajectory.

 

However, RBC's Jackson said Beijing may have waited too long to raise interest rates, and that the necessity of more aggressive rate hikes could have a bigger impact on economic growth than currently assumed.  While Hong Kong's stock market was shut for a holiday Monday, mainland Chinese bourses initially cheered the rate hike, with the Shanghai Composite rising more than 1% in early trade.  However, the shares reversed sharply in late afternoon action, with the Shanghai Composite 2.1% .

When's the next hike?

Most analysts believed Saturday's rate move wasn't the end of tighting for China's monetary policy. RBC forecast China's central bank will hike its base lending rate by three-quarters of a percentage point during next year.

 

Bank of America-Merrill Lynch saw China lifting rates in two, quarter-point moves, adding that the central bank will probably feel less pressures to act as inflation cools in coming months. It forecast gains in the CPI will ease to 5% in December, and likely dip to between 4.5% and 5% in the first half of next year.  Though real deposit rates will remain negative for a while, "we don't expect more aggressive rate hikes because Beijing still takes growth as the top priority," said Merrill's China economist Ting Lu in Hong Kong.  Lu said Saturday's announcement would affect quarterly settings of mortgage lending rates from Jan. 1
 

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Nothing in this article is, or should be construed as, investment advice.

 

 

 

 

 

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