China's rate hike complicates bid to control yuan

20 OCT, 2010

China's rate hike complicates bid to control yuan

BEIJING: China's first rate hike since 2007 has laid bare official fears over surging prices but could also complicate Beijing's controversial efforts to keep a lid on its currency, analysts said.

The move announced by the central bank late Tuesday caught global markets by surprise and came before a meeting this week of G20 finance ministers in South Korea , where currency frictions are expected to loom large.

Rising inflation and soaring property prices forced the government to hike one-year lending and deposit rates by 25 basis points each, after a range of previous measures introduced this year proved inadequate, analysts said.

They said the move may also indicate that third-quarter data China is to unveil on Thursday will show the world's second-largest economy grew faster than authorities had expected, easing any qualms about raising rates.

The "decision suggests the acceleration in growth and official worries about property and inflation are more serious than anticipated", said Ben Simpfendorfer, a Hong Kong-based economist at Royal Bank of Scotland .

The rate hike depressed stock markets across Asia Wednesday on worries that any Chinese slowdown could hit fragile global growth. Tokyo's Nikkei index closed 1.65 percent down and the Hang Seng in Hong Kong slipped 0.87 percent.

China's inflation has accelerated in recent months, rising at its fastest pace in nearly two years in August when consumer prices went up 3.5 percent year-on-year, as food prices surged after extreme weather hit crop yields.

At the same time, property prices in major cities have remained stubbornly high and bank lending has continued to grow, defying official moves to dampen both.

"The asymmetric hike suggest that the authorities wished to make deposits a more attractive investment proposition than property to discourage property speculation," Nomura analysts Tomo Kinoshita and Chi Sun said in a note.

Beijing has delayed raising interest rates until now partly due to concerns it could attract speculative money chasing a relatively higher yield, making it more difficult to keep the Chinese yuan stable.

The central bank has to buy the dollars flowing into China's export machine to prevent the yuan from rising too quickly. The dollars then pile up on the country's world-beating stockpile of foreign currency reserves.

Beijing pledged in June to let the yuan trade more freely and the currency has since strengthened slightly. But Beijing maintains a tight grip on the yuan despite US and European pressure to let it appreciate.

The yuan was trading Wednesday at 6.6546 to the dollar, weaker than Tuesday's close of 6.6447.

Critics of China's yuan policy say it undervalues the currency by as much as 40 percent to give Chinese exports an unfair edge on world markets.

Higher interest rates could lead to an "intractable monetary policy dilemma" for Beijing by encouraging more foreign capital inflows into China, said Nicholas Consonery, an analyst at Washington-based Eurasia Group.

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