International | Apr 28 2006
Growth in the Chinese economy in the March quarter was 10.2%, higher than consensus forecasts of a 9.7% increase and strong enough to produce a policy response by the Chinese central bank.
The response wasn’t the one expected by the markets though, as the People’s Bank of China lifted one-year interest rates to 5.85% from 5.58%, the first increase in such rates since October of 2004. As Danske Bank notes, the expected action was for higher required reserve ratios in the banking sector.
The economics team at Commonwealth Bank agrees it was an unexpected move, but suggests there could now be further gradual increases in lending rates as the central bank continues with its attempts to bring growth down to more sustainable levels.
Morgan Stanley’s Andy Xie suggests the move is a response to an economy that is overheating, with higher rates an attempt to limit the current booms in lending and investment.
He agrees additional measures are likely, noting some regional authorities are already moving to introduce new measures to slow credit growth such as lifting deposit requirements on new loans.
Having said this, Xie makes the point the move was only a superficial approach and doesn’t address the fundamental problem, which is expectations of further gains in the Chinese currency against the US dollar. As long as expectations remain for the currency to appreciate money will continue flowing into China, Xie suggests.
Some market participants suggest the move may be a precursor to an increase in the value of the currency, though opinion appears fairly evenly divided on the prospects for an increase in the short-term.
Danske Bank pointed out one implication of the move to lift rates is it tightens liquidity not only in China but throughout Asia. Potentially this is negative for commodity prices in the bank’s view, as it will have the effect of making them slightly more expensive for the Chinese to purchase. Evidence of this concern was seen in the immediate reaction by commodity markets, which were generally weaker on the news of the increase in rates.
