China raises interest rates for fourth time this year

 @ibtimes
on August 21 2007 8:17 AM

China raised interest rates on Tuesday for the fourth time this year to stabilize inflation after consumer prices rose in July at the fastest pace in more than a decade.

The People's Bank of China (PBOC) said it was raising the rate that banks pay for one-year deposits by 27 basis points, to 3.60 percent, and the corresponding benchmark for lending rates by 18 basis points, to 7.02 percent from 6.84 percent.

The increases go into effect on Wednesday.

Although the timing was a surprise, the action itself was not despite turbulence in global markets that has prompted the Federal Reserve to cut its discount rate and hold out the prospect of a reduction in the federal funds rate.

Most economists had forecast an increase, both to anchor inflationary expectations and to reduce the incentive for savers to take their money out of the bank -- where real deposit rates are deeply negative -- and pile into the surging stock market.

The PBOC is concerned about falling real deposit rates spurring the flow of funds out of deposits into equities. We don't think this is a response to strong growth, said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong, said.

Although the economy expanded 11.9 percent in the second quarter from a year earlier, Lin Songli, an analyst with Guosen Securities in Beijing, agreed that, by raising lending rates less than deposit rates, the central bank was signaling it was not intending primarily to slow the pace of growth.

The move is mainly targeting inflation, and the authorities might have reached a consensus that investment growth is not a big problem now, Lin said.

Consumer prices surged 5.6 percent in the year to July, the fastest pace since early 1997, because of a spike in the cost of pork, eggs and other foods.

Although non-food inflation fell to 0.9 percent in July, policy makers are concerned that price increases are already rippling out across the economy.

It's also meant to curb fast growth in the stock market, which is now at historical highs and is rising very fast, Lin said.

The main Shanghai share market is up 80 percent this year on top of a 130 percent leap in 2006.

Lin said bank shares were likely to fall hard on Wednesday in response to the rate rise.

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