International | Aug 21 2006
By Chris Shaw
In a move that surprised many in the market from a timing perspective but not from a policy perspective, the People’s Bank of China (PBOC) late last Friday announced it was lifting official interest rates and deposit rates by 0.27%, the first change to official rates since a similar increase in the lending rate in April.
According to Danske Bank the move shows the authorities are serious about trying to slow down the rate of growth in the economy and in particular the current high level of investment growth, which is making other policy initiatives difficult.
While accepting the PBOC is serious Danske takes the view the move by itself is far from enough, as while credit growth, which is seen as largely fuelling the economic expansion, may slow, higher rates by themselves are unlikely to be a solution. It suggests simply moving rates higher will in fact encourage additional capital inflows, so the move needs to be matched by additional measures designed to increase the flexibility in the currency.
Standard & Poors agrees, the agency taking the view the moves are but a first step and further moves towards greater reduced controls on the economy, such as a more flexible exchange rate, can be expected.
HSBC shares this sentiment but argues further moves are essential as real interest rates remain low relative to the growth rate in the economy. In its view this means such small interest rate moves are unlikely to prove successful as the environment remains supportive for further capital inflows.
BNP Paribas sees the decision to move now as giving the PBOC greater flexibility, as it now clears the way for a further increase in rates before the end of the year. The Commonwealth Bank suggests the next step is likely to be greater flexibility in the exchange rate, with a widening of the trading band likely by December and more likely by the end of September, which would be supportive for the currency against the US dollar.
Danske Bank also sees such a change in the exchange rate occurring, arguing the move on rates is a good indicator greater flexibility is likely. In its view a more flexible approach towards the currency is required as a change in the exchange rate in combination with higher rates is more likely to be effective in limiting capital inflows, which in turn would help moderate economic growth.
It is forecasting a widening of the currency band against the US dollar from the current 0.3% range to closer to 1%, though it expects any change to be gradual. In its view such a move would be supportive for Asian currencies, a view shared by Commonwealth Bank. JP Morgan also sees the Chinese currency strengthening against the US dollar over the remainder of the year, the broker forecasting a rate of 7.5 against the dollar by the end of December, compared to the current rate of around 8.0.
