China Will `Inevitably' Raise Rates in Battle Against Inflation

China’s reserve-ratio increases forbanks and threats of price controls on essential goods arelikely to prove insufficient to tame inflation, and the centralbank will have to raise interest rates further, economists said.

The People’s Bank of China yesterday ordered a 50 basispoint increase in the amount of money that lenders must setaside, two days after the cabinet announced measures to tackleinflation. A basis point is 0.01 percentage point.

Stocks and oil fell on the central bank announcement,highlighting concern that Chinese efforts to cool the nation’sfastest rise in consumer prices in two years may cause growth tofalter. Analysts at nine banks surveyed this week by BloombergNews predicted the central bank will add to last month’s raterise, the first since 2007, by year-end.

“Monetary policy is being tightened, as it should be, anda rate hike will follow sooner rather than later,” said Shen Jianguang, a Hong Kong-based economist at Mizuho Securities AsiaLtd. who formerly worked for the International Monetary Fund andthe European Central Bank. The next move “inevitably” will beon rates, Shen said.

China’s benchmark stock index has had its biggest two-weekdecline since May amid concern that monetary tightening willhamper spending in the fastest-growing major economy. TheStandard & Poor’s 500 Index and the MSCI World Index slippedafter yesterday’s announcement. The Shanghai Composite Indexearlier closed 0.8 percent higher, paring its weekly decline to3.2 percent.

Wen’s Meeting

Concern that rising consumer prices will undermine theeconomy spurred Premier Wen Jiabao to hold a cabinet meeting onthe issue this week. The measures contemplated by the StateCouncil range from a crackdown on speculation in agriculturalgoods to the imposition of price caps on “daily necessities”if needed.

The meeting came amid concern at the threat increased foodcosts pose to the poorest people in the world’s most populousnation. More than 81 million people in disaster-affected areasmay need food assistance from the government this winter, theMinistry of Civil Affairs said on its website on Nov. 18.

At Societe Generale, Hong Kong-based economist Yao Wei saidthis week that China’s “old-fashioned price stabilizationpolicies” will not be enough to reduce the case for monetarytightening. The possibility of “more interest-rate hikes by theyear-end remains relatively high,” she said.

Controlling Lending

The increase in banks’ reserve requirements, effective Nov.29, was the second announced in two weeks. The aim is to step upliquidity management and “appropriately control” credit andloans, the central bank said on its website.

China’s inflation rate reached 4.4 percent in October,exceeding economists’ forecasts. Standard Chartered Plc analystsyesterday lifted their projection for the consumer price indexfor next year to an average of 5.5 percent, from about 3.2percent for 2010.

While vegetable costs have helped to drive Chineseinflation higher this year, officials need to use tools such asinterest rates to “prevent food inflation from spreading to thegeneral economy,” Wang Tao, a Beijing-based economist for UBSAG. said yesterday.

Inflows of money from the trade surplus, foreign directinvestment, and investors betting on gains by the yuan threatento propel consumer prices after unprecedented lending by banksflooded the economy with cash from late 2008.

Rents, Wage Costs

Standard Chartered, HSBC Holdings Plc, BNP Paribas SA,Citigroup Inc., Credit Suisse Group AG, Mizuho, Royal Bank ofCanada, UBS, and Australia and New Zealand Banking Group Ltd.predict that the central bank will add this year to the quarter-point increases that took the benchmark one-year lending rate to5.56 percent and the one-year deposit rate to 2.5 percent.

“Inflation is showing up in food most obviously, but alsoin rents, service sector wages, and non-food commodities,”analysts including Stephen Green, head of research for GreaterChina at Standard Chartered, wrote in a report yesterday. Thebank anticipates a rate increase by Dec. 31 and three more byJune 30.

Across Asia, China’s inflation compares with deflation inJapan and, at the other extreme, a 9.8 percent rate in India. Inthe U.S., consumer prices rose 1.2 percent last month from ayear earlier.

Besides possible price caps, the State Council’s plans torein in prices include selling state food reserves.

“Price intervention could be counter-productive because itmay cause panic and worsen inflation expectations,” said Liu Li-Gang, a Hong Kong-based economist at ANZ who previouslyworked at the Hong Kong Monetary Authority and World Bank.

Excess liquidity is the “root of the problem” in China,Tao Dong, a Credit Suisse Group AG economist in Hong Kong saidthis week.