China’s Surprise Rate Hike Heralds More And Higher Yuan

The Chinese central bank’s move to raise interest rates was unexpected. Policymakers are getting more nervy about the inflation risk and inflows of hot money.

The rate rises, the first since before the global financial crisis hit in 2008, lift the one-year lending rate a quarter of a percentage point to 5.56% and the deposit rate by a similar amount to 2.5%. We would not be surprised if they turn out to be the first of a series of modest rises over the coming year to 18 months as the central bank starts to mop up the excess liquidity that fueled the re-acceleration of growth following last year’s slowdown. Last week, the central bank increased reserve ratios for selected banks.

The next set of monthly figures are likely to show consumer prices rising at their fastest pace in a couple of years at 3.6% for September and that the third-quarter GDP figure may be stronger than the 9.5% growth expected, but the rate increases are better considered as part of the attempt to dampen a prospective asset bubble, particularly in real estate where we have seen a number of recent measures to curb demand and reduce the obdurately high levels of loans still flowing into property markets. Negative real interest rates would only exacerbate the flow of money out of bank savings and into hard assets, so the central bank has to get ahead of the inflation figures with its deposit rates.

But what is given to policymakers with one hand is taken away with another. Higher rates will encourage more capital inflows from abroad, inflows the People’s Bank of China is already concerned will be swollen by the U.S. Federal Reserve’s expected second round of quantitative easing. And that will put more pressure on the yuan for an upward revaluation, adding further layers of both economic and political complexity to the management of the economy.

It does, however, provide Beijing with a convenient excuse for letting the currency move up ahead of next weekend’s G-20 finance ministers’ meeting without appearing to be bowing to international pressure to do so. We can only wish, too, that  it will also help the world get away from the sterile debate over currency wars.

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2 responses to “China’s Surprise Rate Hike Heralds More And Higher Yuan

  1. Pingback: Inflation Now Policy Concern No. 1 « China Bystander

  2. Pingback: Manufacturing’s Robustness Allows More Interest-Rate Hikes | China Bystander

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