Why indices ignored rise in interest rates

By Wang Lan (China Daily)
Updated: 2007-07-25 09:55

Don't read too much into the latest increase in bank interest rates. The stock market doesn't, as indicated by the stable performance of the leading indices. What the central bank has done in raising interest rates and lowering the tax on interest income was basically a "passive" reaction to bring the interest rate structure in line with the inflation rate.

As correctly interpreted by various investment markets, the seemingly high consumer price index (CPI) in June does not indicate an overheated economy.

The consistent rise of CPI since the beginning of the year has been driven by increasing food prices, while the core inflation, excluding food and fuel, has remained at a low level of around 1 percent in the past two months.

What's more, the food inflation has mainly been coming from surges in meat and egg prices for the past several months. Pork and eggs have been heavily influenced by temporary supply shortages largely caused by animal diseases. Apart from pork and eggs, all other food prices, including grains, fish, fruits, vegetables and processed food, showed little increase.

Pork prices in June rose 59.8 percent year-on-year and egg prices 37.9 percent, largely exceeding the price rise in other food categories, like aquatic products, up 5.2 percent, vegetables, up 4.8 percent, and fruits, down 16.2 percent.

In China's current CPI, food accounts for 37 percent of the index, followed by transport and communications at 14 percent, and entertainment and education at 12 percent. Food prices have contributed to over 80 percent of the inflation in the past two months.

Such a food-driven inflation is widely believed to be a short-lived episode. "This is hardly a picture of rising economy-wide inflationary pressure," said Jonathan Anderson, UBS Securities' chief economist for Asia in a recent report. Economists and analysts clearly don't see inflation as a serious issue for today's China.

The common perception is that there is little incentive for the government to tighten monetary policies in the future. As the central bank said in the statement posted on its website last Friday, the interest rate hike is an effective way to alleviate inflation and help stabilize the general consumer prices.

The reduction of tax on interest income is also a passive reaction by the central bank to help increase return on deposits and help absorb the impact of CPI rise.

Jason Chang, a Standard Chartered Bank economist based in Shanghai, agreed that last Friday's monetary actions seek to improve the real deposit rate and offset the impact of soaring inflation.

The central bank raised the interest rates for the third time this year a day after the National Bureau of Statistics announced that the annual economic growth reached 11.9 percent in the second quarter, the fastest rate in 11 years, and the CPI notched up a 33-month high of 4.4 percent in June.

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