For the first time in three years, China has raised key interest rates by 25 basis points. The move by China’s central bank triggered losses on global stock markets.
The Chinese government keeps tight control on the country's currency
Most stock markets dropped on Wednesday on fears of economic slowdown in China, after the People’s Bank of China announced its first interest rate rise since 2007. China’s central bank increased the benchmark one-year lending and deposit rates by 25 basis points each on Wednesday.
In foreign exchange trading, the euro gained a little compared to the US dollar. "China’s tightening came as a shock, but the country’s intention doesn’t seem to be a cooling of its economy. Instead it has moved to prevent bubbles from bursting," said Tomomi Yamashita from Shinkin Asset Management based in Toyko.
Rising inflation and soaring property prices forced the Chinese government to act, after a range of previous measures introduced earlier this year proved inadequate. Inflation in China rose at its fastest rate in nearly two years in August when consumer prices went up 3.5 percent year-on-year.
Pudong in Shanghai, where property prices have been soaring
At the same time, property prices in major cities have remained extremely high and bank lending has continued to grow, defying the government’s actions to dampen property speculation. China’s rate hike “suggests the acceleration in growth and official worries about property and inflation are more serious than anticipated,” said Ben Simpfendorfer from the Royal Bank of Scotland based in Hong Kong.
Tight grip on the yuan
Beijing has delayed raising interest rates until now partly due to concerns it could attract speculative money chasing a relatively higher yield, making it more difficult to keep the Chinese yuan stable. So China’s central bank has to buy the dollars flowing into China’s export oriented economy to prevent the yuan from rising too quickly.
Beijing pledged in June to let the yuan trade more freely and the currency has since strengthened slightly. But Beijing maintains a tight grip on the yuan despite US and European pressure to let it appreciate. Critics of China’s currency policy say that it undervalues the yuan by as much as 40 percent to give Chinese export products a price advantage on the world markets.
But analysts also say that higher interest rates could also lead to an intractable monetary policy dilemma for Beijing by encouraging more foreign capital inflows into China. This could lead to a risk of further asset and consumer price inflation.
Editor: Grahame Lucas