Friday, December 31, 2010

More Interest Rate Hikes against Inflation in 2011

What a Christmas gift!

On 25 December 2010, the Chinese central bank, People's Bank of China (PBoC), decided to raise domestic interest rates by 0.25% against inflation. It perfectly matches with our expectation stated in our article No More loose Monetary Policy.

Both the benchmark 1-year deposit and lending rates were raised by 0.25% to 2.75% and 5.81% respectively but, the increase in deposit rates for the other time durations is asymmetrically more than that in lending rates, thus attracting Chinese savers to put their money into time deposit accounts.

The timing of this interest rate hike also lets us believe that data insufficiency, as we suspected in our article Real Deposit Rate Exceeded -2%, was the main reason why the Chinese central bank did not raise interest rates immediately earlier this month.

At that moment China had just reported that CPI in November spiked up to an alarming level of +5.1% YoY but this figure definitely could not tell the degree of effectiveness of the those government administrative measures introduced in late November. After all, it is almost end-December now and the Chinese central bank should already know about the data representing impact of the government administrative measures.

We disagree with some speculators who say the Chinese central bank should rely on reserve requirement ratio (RRR) hikes rather than raising interest rates to fight against inflation. Those speculators may just ignore the difference between inflation and inflation expectation.

Reserve requirement ratio (RRR) hikes can mop up the excess liquidity in the monetary system but, it is only good for reducing inflation expectation. Actually its help on inflation is slim because it leaves the problem of negative real deposit rate unresolved.

A responsible central bank, of course, needs to handle the risks of both inflation and inflation expectation. In the X'mas day the Chinese central bank actually gives signal to the market that the importance of negative real deposit rate has to be a concern.

We expect more interest rate hikes against inflation in 2011 as the China real 1-year deposit rate still exceeds our warning level of -2% (now it is 2.75% - 5.1% = -2.35%).

As the timing to raise interest rates and the trend of negative real deposit rate depend, we will continue to monitor the China inflationary risk for you and present our findings whenever necessary.

Please stay focus on our Mr China website so that you may not be surprised by another PBoC interest rate hikes at a time possibly most people can hardly expect.

Related article(s):
Inflation Warning for China


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