China raises rates again??

BEIJING: China's central bank raised interest rates on Saturday, Dec 25 for the second time in just over two months, underscoring concerns that inflation may be entrenched and swift action is needed to get price pressures under control.

The intensification of policy tightening also reflects the government's belief that the economy is fundamentally in a good shape.

Below are some implications what the latest move means for monetary policy outlook and financial markets.CHRISTMAS SURPRISE

The rate rise shows China's top leaders have the task of taming inflation at the top of their agenda, as they had signaled in November, when they said they would intervene to control prices if needed.

Such language, alongside Beijing's official switch of its monetary policy to "prudent" from the previous "moderately loose" in early December, had laid market expectations for tighter policy.

But investors were not sure if the People's Bank of China (PBOC) would move this year given it only just raised banks' reserve requirements on Nov 19, ahead of data which showed inflation at a 28-month high of 5.1 percent.

The PBOC's Christmas Day rate rise is characteristic of its tendency to surprise investors with policy changes when they least expect it.

The move came amid tentative signs that price pressures were spreading beyond food and inflation and could be more stubborn than authorities had expected.

China's real interest rates are deep in negative territory. The one-year benchmark deposit rate is only 2.75 percent after the latest climb, well below November's inflation of 5.1 percent, highlighting the risk that price expectations may spin out of control.

All said, there have also been dovish signals from the government in recent days. Notably, it has raised its 2011 inflation target to 4 percent from this year's 3 percent.


RATE RISE CYCLE

Though announced by the central bank, the decision will have received approval from the highest echelons of power. Once a consensus has been forged in Beijing to raise or cut rates, past experience shows that moves often come in bunches.

This is the second rate rise in the current tightening cycle (the first was announced on October 19) and analysts think that another 50 bps of increases are on the way over the next year.

The PBOC made clear on Friday that it will deploy a range of policy tools to head off inflationary pressures and asset bubbles.

Interest rates are just one item in China's toolkit for mopping up the liquidity that is at the root of the country's inflation problem. Banks' reserve requirements and lending quotas are crude but effective shovels for removing cash from the economy as well.

So far, the PBOC has dragged its feet on jacking up rates, relying mainly on quantitative tightening measures, notably banks' reserve requirement ratio (RRR) and lending restrictions, which are less likely to dampen growth in the economy.

The PBOC has increased RRR six times this year but only lifted interest rates twice.

Some analysts thought China should have raised rates earlier in the year when the country was growing at a double-digit annual pace. But officials were worried at the time about sluggish external demand and uncertain about how the domestic economy would cope when government stimulus was withdrawn.

The view from Beijing now is that the economy has built up a momentum solid enough of its own and tightening is needed to keep it on a sustainable path of growth.

LIMITED MARKET IMPACT

Since the move was relatively mild, there could be a relief rally when the Chinese stock market opens on Monday.

After all, the market had already priced in more rate rises, with the main index in Shanghai down nearly 10 percent since mid-November.

Still, the specter of more tightening will hang over the market, limiting any gains. The government is determined to keep inflation under control, indicating there will be more tightening in the coming year.

The rate rise may suggest that the central bank is less concerned about hot money inflows, and is more willing to let the yuan appreciate at a faster pace and use the currency as another lever to rein in inflation.

In global markets, tighter Chinese policy could fuel investor concerns that growth in the world's second-biggest economy may falter, undermining stocks, commodities and high-yielding currencies.

But many analysts say China's resilient economy can withstand higher rates and they are a good thing for the country in the long run as they prevent the economy from overheating. - Reuters