China hadn't raised its benchmark interest rates since 2007--Why today?

10/19/2010 1:47 pm EST


Jim Jubak

Founder and Editor,

China caught global financial markets flatfooted today, October 19, by raising its benchmark interest rates for the first time since 2007.

The People’s Bank of China raised its one-year lending rate to 5.56% from 5.31% and its deposit rate by 0.25 percentage points to 2.5%.

The move sent markets lower around the world. The Dow Jones Industrials were down 0.9% as I wrote this at 1:20 ET in New York. In Europe the FTSE 100 was down 0.7%. And Brazil’s Bovespa was down 1.6%. (The People's Bank made the announcement after markets in China were closed for the day.)

The timing of the rate increase has set off rampant speculation. China almost never changes its benchmark rates preferring moves such as raising bank reserve requirements as the People’s Bank did last week. So why raise the benchmark rate now?

One theory holds that inflation numbers for September—due for release later this week—will show a pick up to 3.6%. The People’s Bank moved today to show that it’s ahead of the news.

A second theory suggests that the bank’s move is tied to third quarter GDP figures due to be released later this week. Economists are expecting a 9.5% growth rate but, this theory says, the bank may have raised rates because growth will exceed expectations.

Another theory says that the benchmark increase is a reaction to news that new bank lending in September rose and now threatens to exceed the government’s quota for 2010. (See my post )And in reaction to a soaring Shanghai stock market that’s now 27% off its recent lows.

Still another theory says that the benchmark increase is a sign that China and the United States have reached a deal on allowing China’s currency, the renminbi, to appreciate at a faster rate.

And yet another theory says that the increase in the benchmark is a sign of no deal since the increase itself will work to drive the renminbi higher without any formal agreement.

One thing that isn’t surprising is the timing of the increase. Earlier this month bank governor Zhou Xiaochuan said that tools such as raising reserve requirements were sufficient to control inflation. Today’s about face from that position is the kind of big change in policy that often follows one of the Communist Party’s big meetings.

The annual party congress ended yesterday. (For more on what was on the agenda at the party meeting see my post )
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