The surprise timing of China's latest interest rate rise partly reflects political pressure and shows the central bank falls short of the transparency and predictability that are the hallmarks of its rich-country peers.
The People's Bank of China (PBOC) caught markets off guard on Friday by raising banks' one-year deposit and lending rates by 27 basis points to 2.52 percent and 6.12 percent respectively.
Economists had long expected an increase, but a move was not thought to be imminent after slower growth in investment and industrial output in July suggested that a succession of government tightening steps unveiled since April was biting.
The rate rise shows top leaders are very unhappy about the effectiveness of macroeconomic measures in recent months, said Gao Shanwen, an economist at Everbright Securities in Shanghai.
Analysts said the central bank, which was wary of raising borrowing costs for fear of fuelling upward pressure on the yuan, had no choice but to act after Premier Wen Jiabao on July 26 demanded forceful measures to stop the economy overheating.
Government departments have been competing with each other to unveil new tightening measures since the top leadership showed greater determination to strengthen macroeconomic controls, Gao said.
The central bank has also raised reserve requirements twice in recent months, it announced one increase five days before Wen spoke, and it raised bank lending rates in late April.
The PBOC lacks operational independence. It formulates new monetary policies but has to wait until the State Council, or cabinet, gives the green light.
By contrast, the independence of the Federal Reserve makes for greater transparency that helps market watchers form a consensus about the path for U.S. interest rates. And because the Fed's policy-making committee meets on fixed schedules, surprises like the one in China on Friday are unheard of.
Maybe the most important factor is that the central bank lacks independence. It cannot make real decisions, said Qu Hongbin, chief China economist for HSBC in Hong Kong.
I think central banks should guide market expectations, rather than bucking expectations, he said. The central bank needs to change if China is to become a major global player.
The official China Daily admitted that economists faced a tough task forecasting the PBOC's moves, but it defended the bank's smokescreen tactics on the yuan, arguing that greater clarity would make the currency a one-way bet for speculators.
Unpredictability is generally not a good word in economics and business. But at this stage, the central bank's way of managing the exchange rate serves the country's interests by safeguarding economic stability, the paper said in an editorial.
Some analysts reckon that, by wrongfooting the market, Beijing is deliberately seeking to build on the legacy of last year's landmark yuan revaluation to reinforce its message.
The PBOC appears to be trying to use a surprise strategy to enhance the effectiveness of its policy, while the Fed is trying to guide market expectations, said Wang Qing, an economist at Bank of America in Hong Kong.
MORE RATE RISES?
Looking ahead, the path for interest rates is no clearer than it was last week.
The China Securities Journal quoted Wang Xiaoguang from the Academy of Macroeconomic Research, a think tank under the National Development and Reform Commission, as saying that China might raise interest rates again in the fourth quarter.
Andy Xie, Morgan Stanley's chief economist in Hong Kong, said in a note to clients the rate rises so far had been tiny next to China's 11.3 percent GDP growth rate. He forecast one more 27 basis point rise this year and another three or four in 2007.
But Song Guoqing, chief economist at China Stock Exchange Executive Council, a Beijing-based think tank, told the China Securities Journal that the government should call a halt and be wary of tightening too much.
There is more of a consensus on the outlook for the yuan.
Many economists interpret recent comments by Chinese policy makers as accepting that a stronger yuan must be part of the solution for stanching the money flooding the banking system.
The purpose of raising interest rates was to curb investment growth, but resolving the problem of excess liquidity needs faster yuan appreciation, Bank of America's Wang said.
On cue, the yuan