Chinese rate hikes will build pressure on its Pacific partners

TODAY the interest rate hike announced by the Chinese central bank will kick in. This follows yesterday’s announcement by the People’s Bank of China (PBoC) that the benchmark one-year lending rate will increase to 6.31 per cent from 6.06 per cent. At the same time, the one-year deposit rate will rise to 3.25 per cent from 3 per cent.

Fearful of the risk of asset bubbles in its rapidly expanding economy, these moves are part of attempts by China to bring inflationary pressures under control, and are the fourth time since the financial crisis hit in 2008 that China has raised rates. Since the start of the year, the PBoC has also raised the reserve requirement level three times, with the required rate of return currently sitting at 20 per cent.

The timing of today’s rate increase may be a pre-emptive strike agaist economic announcements which are due to be released soon and are set to point to increased inflation. These include the March consumer price index (CPI) figures, due on 15 April, that will probably come in at about 5.5 per cent.

According to Wei Yao, an economist from Societe Generale Cross Asset Research: “We expect limited impacts from this hike on the real economy. The repeated required reserve hikes have effectively tightened liquidity conditions and pushed up borrowing costs. The commercial banks have raised their lending rates much more than the PBoC has raised the benchmark interest rates.”

Negative real interest rates have lasted more than a year and Chinese Premier Wen Jiabo has described inflation in China as “a tiger that once set free will be very difficult to put back in its cage.” Nick Beecroft, senior markets consultant at Saxo Bank echoes Jiabo’s concerns about the risk of inflation: “The rise in Chinese interest rates is the latest tentative step along the tightrope which China is walking between the need to avoid social unrest driven by higher prices and, on the other hand, to dodge a dramatic economic slowdown or property crash, as a result of a rapid monetary tightening. I expect more rate rises and also an accelerated contribution from exchange rate appreciation in the battle against inflation, which seems set to break the 5 per cent barrier over the next few months.”

According to Guido Stiel, co-manager of the Allianz RCM BRIC Stars fund, the announcement of today’s rate rise was largely anticipated: “It was the first of two increases of 25 base points expected this year and we expect the second one to come in July, around the same time as we expect to see a tailing off of inflation through base effect easing momentum. With the exception of food price rises, there is low inflation due to high competition in capital good markets”

Doug Turnbull, fund manager of the Neptune Greater China Income fund says that food price inflation is a significant factor in the Chinese economy: “Consensus seems to be that with the rate hike, the peak of the CPI, which had previously been expected in July, has been brought nearer and could be at its peak now. But we think that it may still be a way off. Inflation could rise up for the next quarter, into the second half of the year, driven by food inflation. Food prices in China have been rising by around 11 per cent per annum while non-food prices have risen by 2.3 per cent. With food prices making up 30 per cent of the CPI figure their continued rise will have a significant effect. The point at which people will get bullish and buy Chinese equities is when the policy ceases to be tightening. We are approaching that now.”

Due to its tightly controlled nature, the rate hikes will not have a direct effect on the Chinese currency. However, the announcement will have a big effect on countries with Chinese exposure. These invariably see a selling-off of currency in the aftermath of a Chinese rate hike, as there is a perception that higher interest rates hinder China’s growth and with it their demand for imported commodities. With the majority of their exports being to China, the Australian dollar is especially sensitive to PBoC rate hikes.

With the Australian economy being put under pressure in the aftermath of natural disasters earlier in the year, at the same time as being influenced by China addressing its inflation fears, the Autralian dollar-dollar pair could well present a mid-long term opportunity for investors to take advantage of China’s rate hikes over the course of the year.