China Rate Hikes

After yesterday's cautious comments on China's economy by Premier Wen Jiabao, China is raising rates:

China's central bank said Saturday it will raise interest rates in an effort to rein in the country's red-hot economy, according to published reports.

The People's Bank of China will raise rates 27 basis points, lifting the benchmark one-year lending rate to 6.39% and the one-year deposit rate to 2.79%. The changes will take effect Sunday.

More context here (Reuters):

The yuan has now appreciated about 4.8 percent against the dollar since Beijing revalued it by 2.1 percent and set it free from a dollar peg to float within managed bands in July 2005. It touched a post-revaluation high on Friday.

But many economists say the only way to close off the tap of liquidity at the source is to let the yuan strengthen even more so as to make Chinese exports more expensive.

That would help ease the swelling trade surplus, which hit a near-record $23.76 billion in February, far more than expected.

The central bank, in an effort to keep the yuan stable, buys most of the dollars generated by the surplus, for which it must in turn print yuan, thus flooding the banking system with cash.

Gao Shanwen, chief economist at Everbright Securities in Shanghai, said he thought the interest rate rise would only exacerbate that problem.

"Higher interest rate rises can help slow down investment and domestic consumption. With domestic consumption weakening, more and more goods would have no market at home and have to be exported abroad, which would make the trade surplus even larger," Gao said.

Gao has a point: many skyscrapers, consumer goods etc. are made on the premise that consumption will grow sufficiently over the coming year to fulfill orders and demand in the future. If consumption comes off, then this means exports play an increasingly important role in the growth of China's economy. That means you need a very strong U.S. economy to swallow up the excess consumption which cannot be provided for at home, as well as an increased addition of foreign investment to keep those new skyscrapers full.

The effects a rate hike like this - and future rate hikes - may have on global commodity prices will be interesting to see. I pointed out this week that steel may become a lay casualty (for the above reasons), while also pointing to pending rate hikes in China and India, and the consequences of such (Steel & The Carry Trade: Reflexive Market Duality).

Further notable commentary from Aaron Task today at thestreet.com too over next week's implications (Coming Week: Spotlight On Central Banks):

In the wildcard department, Chinese Premier Wen Jiabao made some eye-opening comments Friday, characterizing his country's growth as "unstable, imbalanced, uncoordinated and unsustainable," Bloomberg reported.

The reaction to Wen's comments was notably muted Friday, which may suggest Asian markets' late-February rout was an isolated event. But similar to the time the premier's Chinese New Year holiday declaration about corruption and fraud spurred those massive losses in Shanghai, investors will have two days to mull Wen's latest comments, as detailed here.

In addition to any postmull reaction to Wen's warnings and the subsequent rate hike by the People's Bank of China Saturday, Monday is also the first day of a two-day BOJ policy meeting. Japan's central bank is largely expected to keep rates unchanged at 0.5%. But any comments about future rate hikes could revive fears of an unwinding of the yen carry trade -- or even actual unwinding of trades made by borrowing yen to finance investments in high-yielding securities around the world.

Summary: Markets in Asia Monday/Tuesday (and knock-on effects on the Dow) will be notable.

Comments

[patrick kerr]

this chart at oildrum says it all---it is a must see, check it out!

http://www.theoildrum.com/story/2006/1/29/23825/7257

pk