China's central bank raised interest rates Tuesday for the first time in nearly three years, a move that reflects Beijing's rising concern about inflation and could mark the start of a more aggressive phase of monetary tightening.
The People's Bank of China said it was raising benchmark rates by 25 basis points, taking the bellwether one-year deposit rates to 2.5 percent and one-year lending rates to 5.56 percent.
If there was ever any doubt about China's role in driving the stuttering global economic recovery, the impact was felt by markets across the board. Oil and gold prices tumbled, stocks turned negative in Europe and the dollar jumped.
"The interest rate rise is entirely outside of market expectations," said Zhu Jiangfang, chief economist at CITIC Securities in Beijing.
"The recent rise in headline inflation has put the real rate into negative territory. And I think that's why the central bank needs to raise interest rates in such a hasty way," The Reuters quoted Zhu as saying.
Finance ministers of the G20 major economies will aim to tackle the global currency strains in a meeting in South Korea starting on Friday. The country also hosts a G20 leaders' summit in November.
In the view of some, it is about time for China to embark on a more aggressive tightening cycle. To date, it has relied on lending restrictions and banks' reserve requirements to keep growth from boiling over.
"Fundamentally, policy rates are just too low for an economy that's growing around 10 percent. To avoid bigger distortions, China needs to start moving rates to more appropriate levels," said Rob Subbaraman, an economist with Nomura in Hong Kong.
"China's economy looks as though it's decoupling from other major economies, and its policies should as well," The Reuters quoted Subbaraman as saying.
A number of leading economists, including some advisers to the central bank, have urged an increase in deposit rates to keep savers' returns in positive territory.
China reported consumer inflation of 3.5 percent in August and economists expect that the pace climbed to 3.6 percent or even higher in September.
Still, the increase in rates is surprising given that several top leaders have recently expressed confidence that inflation is under control, and have said that higher rates would potentially suck in speculative capital from abroad.
"They did it now likely because Thursday's GDP and CPI data is too strong for them," said Dariusz Kowalczyk, senior economist at Credit Agricole CIB in Hong Kong.
Economists polled by Reuters last month had expected an extended period of interest rate stability in China, with no increase until the second quarter of 2011.
Propelled in part by these expectations of low rates, Chinese asset prices have shown signs of taking off.
The Shanghai stock index, a laggard for much of this year, has jumped 16 percent in the past nine trading days. And despite a months-long campaign to clamp down on the real estate market, housing inflation has started to perk up again.
"This is a bucket of cold water for the market," said Zhang Yuheng, an analyst with Capital Securities in Shanghai. "The hike itself is not a big one, but the psychological impact is big as the expectations for more rate hikes will appear."
Higher rates make yuan-denominated assets more attractive and could in theory place upward pressure on the Chinese currency. Until a fall on Monday, the closely managed currency had risen 2.5 percent against the dollar since the end of August, its quickest pace of appreciation since a 2005 revaluation.
Source: Agencies / People's Daily OnlineRelated Reading
