China raises interest rates

China has raised its interest rates as its economy shows signs of overheating. Inflationary pressures, exacerbated by America’s intention to start a second round of quantitative easing, have also intensified.

Last night, the Bank of China said in a statement it would raise the one-year rate to 5.6% from previously 5.31%. At the same time, it announced it would raise the one-year deposit rate to 2.5% from 2.25%.

This is the first raise in interest rates since the start of the global financial crisis. It comes just two days before third quarter GDP data is published tomorrow.

The move suggests that mounting inflationary pressures, which have reportedly caused social discontent, have forced China’s policymakers to raise interest rates.

“China’s economy is overheated, necessitating growth well below trend to cool it,” Diana Choyleva, a director at Lombard Street Research (LSR), writes in LSR’s daily note

“But hammering domestic demand as the authorities have done so far, using administrative measures as well as rate hikes now, has brought the wrath of the US, which wants faster yuan appreciation.” (article continues below)

Choyleva says the move comes too late and whichever combination of tools is used, China’s short-term growth prospects look bleak.

In August, the Chinese central bank published a monetary policy report in which it hinted of possible reforms. Although the overtone of the report is positive with the bank stating that the economy is “expected to grow in a more stable and sustainable way on the basis of the recent rapid rebound”.

In the first half of this year, China’s economy performed well and in line with what its macroeconomic management policies were targeting. Consumption picked up rapidly; investment growth moderated but remained high; foreign trade experienced a fast rebound; the contributions of consumption, investment, and exports to economic development were more balanced; both industrial output and corporate profits went up by a large margin. China’s consumer price index rose by 2.6% year-on-year and gross GDP reached Rmb 17.3 billion (£1.7 billion), an 11.1% increase year-on-year.

To boost economic growth, China’s government has launched a series of new measures, which will step up adjustments in the economic structure and nurture new growth points.

Yet the monetary policy report also notes that “given the still complicated and serious conditions at home and abroad, as well as the many uncertainties regarding economic development, macroeconomic management is facing a dilemma.”