December 20, 2007 / 10:31 AM / in 10 years

China raises key interest rates to fight inflation

BEIJING (Reuters) - China raised its benchmark interest rates on Thursday for the sixth time this year, the latest in a series of tightening steps to contain inflation and prevent the world’s fourth-largest economy from overheating.

A bank employee counts yuan notes at the Bank of Beijing, July 22, 2005. China raised interest rates on Thursday for the sixth time this year, the latest of a series of tightening steps to cap inflation and prevent the world's fourth-largest economy from overheating. REUTERS/Jason Lee

However, it also lowered the rate for demand deposits — those that can be withdrawn at any time — to encourage savers to tie up their cash for longer periods rather than having it readily available to shift into shares or property.

The People’s Bank of China increased the one-year benchmark deposit rate by 27 basis points to 4.14 percent, and the one-year lending rate by 18 basis points to 7.47 percent.

“This move is to help prevent the rapidly expanding economy from boiling over and sectoral price rises from turning into conspicuous inflation,” the central bank said in a statement.

China is battling inflation of 6.9 percent, an 11-year high, which until now has been driven by soaring food prices but has shown worrying signs of spilling over to the broader economy.

Earlier this month China’s top leaders announced they would shift to a “tight” monetary policy from a decade-long “prudent” stance to prevent the economy from boiling over and keep inflation under control.

“The rate hikes are not surprising to me given the government’s repeated vows,” said Pan Jiang, head of research at Franklin Templeton Sealand Fund Management Co in Shanghai. “This has been factored into the stock market, but the property sector will take another hit.”

The central bank’s previous rate rise was on Sept 14. It has also raised the proportion of deposits that banks must hold in reserve 10 times this year to a record high 14.5 percent and has imposed strict lending quotas on lenders to check credit growth.

At the same time as raising one-year deposit and lending rates, the central bank cut the rate for demand deposits on Thursday by 9 basis points, to 0.72 percent.

“People want to keep money in liquid forms, so they (the authorities) want to reverse that and pull money back into time deposits,” said Paul Cavey, an economist at Macquarie in Hong Kong. “If they’re able to reverse that, it can have a cooling effect on asset prices in China.”

Whereas western central banks usually raise or cut interest rates by a quarter-point or a half-percentage point, China makes adjustments in increments that are divisible by nine to make it easier for banks, which calculate interest based on a 360-day year.


Some analysts had thought China would be reluctant to raise rates when the United States was in a cutting phase, lest it attract inflows of hot money betting on appreciation of the yuan


One-year yuan certificates of deposit now earn 4.14 percent, a whisker below the U.S. benchmark federal funds rate of 4.25 percent, and markets confidently expect more easing from the Federal Reserve while China moves in the opposite direction.

But economists say Beijing has let it be known that its overriding concern is to keep a lid on inflation, which has at times in the past sparked social unrest.

“What is clear is that sentiment in Beijing is changing — and it’s likely that (the first quarter of) 2008 will see more aggressive action to attempt to control inflation,” Stephen Green, head of China research with Standard Chartered Bank in Shanghai, wrote in a note to clients.

Part of the reason for raising deposit rates by more than lending rates is to bring real deposit rates, which have been eroded by inflation, closer to positive territory. This should give people less of an incentive to speculate on stocks and property, analysts say.

The cost of borrowing remains well below the returns businesses can earn by investing in new plant and equipment, or that individuals have been able to achieve by punting on the country’s stock markets, at least until a recent correction.

Interest rate decisions taken by other Asian central banks on Thursday underline the varying challenges facing them: Taiwan raised rates by 12.5 basis points to curb inflation, while the Philippine central bank cut its overnight rate by 25 basis points, citing benign price pressures.

Additional reporting by Langi Chiang in Beijing and Charlie Zhu in Shanghai; Editing by Jason Subler/David Stamp

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