China raises interest rates; inflation likely to break back above 5% for March

04/05/2011 12:58 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Surprise! Just when most analysts had convinced themselves that China was done raising interest rates for a while, the People’s Bank of China increased its benchmark lending interest rate, effective tomorrow April 6, to 6.31% from 6.06%.

The bank’s one-year deposit rate will go to 3.25% from 3%. (Of course, with inflation running near a 5% annual rate, keeping money in the bank even at the new deposit rate is a losing proposition.)

The interest rate increase is the sixth by the People’s Bank since the end of the global financial crisis and the fourth increase since October.

The timing of the interest rate increase suggests bad news to come in the March inflation numbers due to be released on April 15. The consensus among economists is that inflation increased to a 5.1% annual rate in March from 4.9% in February and January. The 5.1% would match November’s 5.1%, a 28-month high.

A move up to 5.1% in March would indicate, as many economists have argued, that the decrease in inflation in January and February was a statistical artifact that reflected a temporary improvement in year-to-year price comparisons rather than any actual decrease in inflation.

It’s hard for me to see how an increase in interest rates without a speed-up in the appreciation of the yuan is going to do much to slow inflation in China. The yuan is up only 4% against the dollar in the last year and without some signal that investors risk a faster rate of yuan appreciation, tomorrow’s interest rate increase will only make China a more attractive market for hot money. With Chinese rates at 6.31% and U.S. benchmark short-term rates at 0% to 0.25%, for example, China faces a constant inflow of speculative capital that adds to the money supply and pushes up prices for speculative assets such as real estate.

Add the inflationary pressures of higher oil prices and rising food prices and tomorrow’s increase isn’t likely to be “one and done.” A survey of economists conducted by Bloomberg showed a consensus projection of a 6.56% benchmark interest rate in China by the end of 2011.

What may give Beijing some relief on the inflation front is an expected interest rate increase from the European Central Bank on Thursday and projected increases from the Bank of England and the U.S. Federal Reserve later in the year. Higher interest rates in those markets would relieve some of the pressure from global hot money flows on China (and other emerging markets.)

But considering the size of the yield gap between China and the European Union or the United States, I don’t think China should count on help arriving very quickly.

 

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