China stocks reverse; Shanghai finishes up 2% on belief that yesterday's interest rate hike will be last one

10/20/2010 2:50 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Well, that’s one way to read it.

After dropping in the first hour of trading, China’s stocks climbed,with the Shanghai Composite Index going from a 1% loss in the first hour to a 2% gain at the close.

Investors and traders in China have apparently decided that yesterday’s increase in the country’s benchmark interest rates, the first increase in these rates by the People’s Bank of China since 2007, will slow inflation and deflate the asset bubble in real estate all by itself. That would remove the need for any future measures to control inflation and real estate speculation. And stocks have rallied on their sense of relief that this is the last tightening that asset prices need to fear.

Well, most stocks, anyway. China Life Insurance and Ping An Insurance, for example, gained 4% each. But real estate stocks didn’t rally from their initial drop at the open. China Vanke finished the day down 6%, for instance.

I find this a rather curious reaction to the interest rate increases and one that isn’t likely to last for long. Inflation numbers for September, due for release tomorrow, will be the first test.

The whole idea that China’s runaway money supply, excessive bank lending, and speculative real estate bubble can be controlled by one round of 0.25 percentage point rate increases goes against China’s economic experience of the last two years. China’s economy and its speculative asset markets have stubbornly resisted all attempts to slow them down.

In my opinion yesterday’s interest rate increases are extremely unlikely to be one-time events.

And if they’re not, traders’ optimism will face a very severe test.

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