China surprised the markets this week by raising benchmark interest rates for the first time in three years. Its one-year lending and deposit rates both went up by 0.25%, climbing to 5.56% and 2.5% respectively. The unexpected tightening in the world’s fastest-growing major economy and key source of commodity demand caused a bout of jitters among investors in risky assets. The dollar jumped and oil and copper fell by 3.6% and 2.5% respectively.
What the commentators said
This step to temper inflation and strong growth of around 10% is “not before time”, said Lex in the FT. Previous increases in banks’ reserve requirements have had scant impact. Inflation is at a two-year high of 3.5% and bank lending has been far higher than expected. The money is causing rampant property inflation, with nationwide prices 9.1% up on a year ago.
But rates are still negative, said Andrew Peaple in The Wall Street Journal. So people have an incentive to put money in asset markets rather than keep them in savings accounts to achieve better returns. There is more tightening to do. However, the trouble with further rate hikes is that it will encourage yet more inflows of money into the economy, implying more upward pressure on inflation and asset prices. Allowing the yuan to rise would be another way of tempering inflation (by raising import prices), but the authorities fear that allowing it to climb too quickly will damage the crucial export sector.
Yet failing to move on the yuan, especially as the trade surplus has soared, “has brought the wrath of the US and EU upon Beijing”, increasing the danger of protectionism, noted Lombard Street’s Diana Choyleva. China is trying to perform a “balancing act” of maintaining manageable inflation and robust growth, said Stephen Smith in the FT. As it tries to cool the economy, this is going to become increasingly difficult. There are likely to be plenty more jitters in risky assets over the next few months.