China hikes interest rates to damp inflation

Updated: 2011-02-09 06:10
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BEIJING - The People's Bank of China (PBOC), the central bank, announced Tuesday it would raise benchmark one-year borrowing and lending rates by 25 basis points beginning Wednesday.

The rate hikes come amid increasing pressure on the Chinese government to control inflation.

After the hikes, the benchmark one-year deposit interest rate will climb to 3 percent, while the one-year loan interest rate will reach 6.06 percent.

As for two-year and three-year deposits, the interest rates will be 35 basis points higher to 3.9 percent and 4.5 percent, respectively. The interest rate for mortgage and other loans of more than five years will rise 0.2 percentage point to 6.6 percent.

This is the first rise in China's one-year benchmark interest rates this year and signals a renewed effort to cool prices and tighten liquidity.

Analysts said the timing of the hike, immediately after the Lunar New Year holiday, would send a strong signal to the market that the PBOC was paying more attention to inflation.

"Though the December consumer price index (CPI) slid slightly from November, we are still facing great inflationary pressures in the first half of this year," said Professor Zhang Liqing, president of School of Finance with the Central University of Finance and Economics.

"This is the fundamental factor behind the central bank's interest rate hikes this time," said Zhang.

China's CPI, a main gauge of inflation, rose 4.6 percent in December year on year, slightly lower than November's 5.1 percent, which was a 28-month high.

For the whole of last year, the CPI was up 3.3 percent and exceeded the government's target to keep it below 3 percent.

"The Lunar New Year gift by the central bank (to raise interest rate) is not surprising because the yuan-denominated new loans in January will possibly surpass 1 trillion yuan (about 151.8 billion U.S. dollars), thus pressing the central bank to quicken its pace to tighten liquidity," said Wang Jun, a macro economy researcher at China Center for International Economic Exchanges.

"Moreover, it is very likely the CPI will jump to a fresh high in January, making it necessary for the central bank to resort to tools such as interest rates hikes to curb inflation," Wang said.

Also, to support the central government's macro control efforts to crack down on housing speculation, the central bank will have to adopt stricter financial policies to tame soaring property prices, he said.

Wang anticipated the central bank would continue hiking bank reserve requirement ratios and interest rates to squeeze lending and control prices in the future.

"There is one thing that is sure, we are now entering the cycle of rate hikes," he added.

Many economists expect the January CPI figure to stand above 5 percent, while new loans in January would be around 1 trillion yuan.

The National Bureau of Statistics is to release the January CPI figure about February 15, when the central bank will also issue the new loan figures for January.

The PBOC announced on January 30 that keeping overall price levels under control would be its top priority in 2011 by adopting a "prudent" monetary policy.

Zuo Xiaolei, chief economist for the China Galaxy Securities, said the PBOC's rise of benchmark interest rates was within the market's expectation and she predicted a similar increase of bank reserve requirement ratios by the end of February or early March this year.

"It is hard for the central bank to set the pace of rate hikes, " Zuo said, "and according to my observation, the PBOC will increase interest rates every two months, so the central bank will possibly hike rates three times in the first half of this year, if necessary."

After the PBOC's latest hike in bank reserve requirement ratios by 50 basis points on January 14, China's major banks will have to set aside a record high of 19 percent of their reserve and small- and medium-sized banks will have to keep 15.5 percent of their deposits as reserves.

The Chinese economy posted a better-than-expected growth of 10.3 percent in 2010, up from 9.2 percent in 2009, adding to the country's pressure to prevent overheating and control prices.

According to PBOC data, Chinese banks granted 7.95 trillion yuan (1.2 trillion U.S. dollars) of yuan-denominated new loans last year, with China's broad money supply (M2), which covers cash in circulation and all deposits, jumped 19.7 percent year on year to 72.58 trillion yuan at the end of 2010.

Since October 19, 2010, the PBOC has raised the benchmark interest rate three times and increased the bank reserve requirement ratio four times in less than four months.

The PBOC hiked interest rates twice in October and December 2010 to deal with rising inflation and soaring asset prices.