Pace of Chinese investment quickens, rate rise seen

BEIJING (Reuters) - Chinese capital spending in October rose at the briskest pace in over a year, rounding out a strong batch of monthly economic data and cementing expectations of a fresh rise in interest rates, possibly as early as Friday.

Capital spending in urban areas on fixed assets such as factories and power plants increased 26.9 percent between January and October compared with the same period last year, the National Bureau of Statistics said.

It was the fastest year-to-date pace since September 2006, eclipsing forecasts of a 26.3 percent rise and the 26.4 percent increase in the first nine months.

Economists calculated that investment spending in October alone was up 30.7 percent from a year earlier. JPMorgan Chase said that was the quickest monthly clip since June 2006.

"That makes an interest rate rise more likely today. Everybody in the market is now expecting it," Qiu Gaoqing, an analyst with Bank of Communications in Shanghai, said.

Shanghai stocks and the yuan eased on Friday as investors focused on the potential for higher interest rates.

The People's Bank of China (PBOC), the central bank, has already raised interest rates five times so far this year and ordered banks on nine occasions to hold more of their deposits in reserve instead of lending them out.

Mingchun Sun, an economist with Lehman Brothers in Hong Kong, agreed that a rate rise was on the cards.

"We expect one 27 basis-point hike by the end of this year, and it's possible that it could even happen today or tomorrow," he said.

China shifts its interest rates in increments such as 0.27 that are divisible by nine to make it easier for banks, which levy interest based on a 360-day year, to calculate the new payment changes.

A HOT ECONOMY

Chinese policy makers have been trying to cool over-investment for fear that excess supply will drive down profit margins and leave companies unable to service their debts.

"I'm pretty worried about this strong number because we think that the overcapacity issue is already a big problem, and this number is definitely making this more severe," Sun said.

The government has tightened land-conversion and environmental-protection rules, taking particular aim at industries that consume a lot of energy and spew out pollution.

Slightly softer factory output and export growth in October had prompted some economists to conclude that these measures might be biting. The investment report suggested they are not.

Capital spending accelerated in real estate, in smelting and pressing of non-ferrous metals such as copper, aluminum and zinc, and in non-metal minerals including cement.

Moreover, investment in new projects increased by 26.5 percent in the January-October period, up from 24.2 percent in the first nine months and just 6.4 percent in the first half.

Even after five rate rises, the one-year lending rate of 7.29 percent remains attractive given China's strong economic growth and fast-rising profits. Moreover, companies finance more than half of their investment from retained earnings, not bank loans.

The pick-up in investment follows figures earlier this week showing a record trade surplus in October; the sharpest rise in retail sales since the government started issuing the data in 1999; faster money and credit growth; and a rebound in consumer price inflation (CPI) to a nearly 11-year high of 6.5 percent.

Taken together, they leave the world's fourth-largest economy on track to grow by more than 11 percent for all of 2007, the fifth straight year of double-digit expansion.

"This higher investment number, plus a rebound in headline CPI and accelerating credit growth, should give the PBOC more than enough reasons for taking immediate tightening actions," said Qu Hongbin, HSBC's chief China economist.

He said he expected a rise of at least 0.27 percentage point as early as this week.

JP Morgan is also in the pack expecting an increase, but the bank struck a note of caution on the timing.

The rationale for a rise is to lift inflation-adjusted deposit rates -- now 3.87 percent for one year -- out of negative territory quickly to discourage people from investing their bank savings in the frothy stock market, economist Qian Wang noted.

"But with the domestic equity market already in correction mode, the urgency of an aggressive rate hike has been reduced," she said in a note to clients.

The stock market was down more than 2 percent in early afternoon, partly in anticipation of higher borrowing costs, and is now 14 percent off its peak, scaled on October 16.

The yuan eased a touch to 7.4230 per dollar, as the central bank set a lower reference point for the day's trading, which traders said may be aimed at keeping the currency stable before raising rates.

(Reporting by Langi Chiang and Jason Subler; Writing by Alan Wheatley, Editing by Ken Wills and Neil Fullick)