China takes another step toward fighting inflation, ending its currency peg

04/07/2010 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The People’s Bank of China, the country’s central bank, will sell three-year bills for the first time since June 2008. The sale is a likely precursor to either an increase in official interest rates by the central bank or an end to the renminbi/dollar currency peg. In March 2007 the People’s Bank raised interest rates two months after selling three-year bills. The bank hasn’t raised interest rates since December 2007.

Issuing higher yield bills would be one way for the central bank to reduce lending by China’s banks. The theory is that a higher yielding bill would draw some money that banks would otherwise use to make new loans. At yesterday’s auction of one-year bills, the market set the yield at just 1.9264%. That’s below the 2.7% rate of inflation in February.  

The People’s Bank is historically very reluctant to raise the official one-year lending rate, preferring measures such as increasing requirements for bank reserves as a way to control the money supply. But bank officials are increasingly saying that an interest rate increase may be the only way to fight inflation. People’s Bank advisor Li Daokui told the China Securities Journal on April 6 that the central bank would raise interest rates if inflation rose above 3%.

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