Easing inflationary pressure and concern over the economy may trigger sharp interest rate cut

With the easing of inflationary pressures towards the end of the last year (November 2008: 2.4 per cent), expectations on the PBC to cut interest rates by large margins gained momentum in the beginning of January 2009. China Daily reports of recent analyzes in China that expect a rate cut in the not-too-distant future of up to 0.81 percentage points. The likelihood of yet another sharp rate cut – after the 1.08 percentage point decrease in November 2008 – certainly will depend on the December 2008 CPI figures and the inflation outlook for 2009. Both is expected to be low; more detailed information should be available before the start of the Chinese New Year (26 January 2009).

23-DEC-08: PBC cuts benchmark interest rate by 0.27 percentage points to 5.31 per cent

In its fifth interest rate cut in four month the Chinese central bank, the PBC, cut the benchmark lending rate by 0.27 percentage points effective on 23 December 2008. This new rate cut comes at the background of huge drops in the inflation rate, which stood at 2.4 per cent in November 2008. According to China Daily, Stephen Green of the Standard Chartered Bank commented the move: “Monetary policy is now all about freeing up funds to be lent to government-backed investment projects, as well as driving down borrowing costs.”

26-NOV-08: PBC cuts benchmark interest rate by 1.08 percentage points to 5.58 per cent

After three rate cuts since 15 September, the PBC decided today to cut the benchmark lending rate for the fourth time in 3 months. Effective on 27 November 2008, the lending rate will be decreased by 1.08 percentage points to 5.58 per cent. This is the biggest interest rate move since September 1997, when the PBC decreased rates by 1.44 percentage points. In recent years the PBC more widely adopted a policy of fine-tuning with rate moves of around 0.27 percentage points. China Daily commented on the rate decision as “a desperate effort to jumpstart capital investments, boost housing sale and propel domestic consumption, amid an increasing chilly economic winter of the world.”

Recent monetary and credit growth figures showed a good relaxation of inflationary tendencies in China. At that background, the drastic rate cut comes at the right time in support of the fiscal stimulus package announced earlier this month.

29-OCT-08: PBC cuts benchmark interest rate by 0.27 percentage points, the third rate cut in six weeks

China, along side the US Fed, cut its benchmark lending interest rate for the third time in six weeks by 0.27 percentage points to  now 6.66 per cent. The move becomes effective on 30 October and is a clear sign of worries that economic growth may suffer of the financial crisis  In fact, Q3/2008 GDP growth slowed to 9 per cent, the lowest quarterly growth rate since five years. At the same time, CPI  inflation further eased to 4.6 per cent in September 2008 allowing some scope for the central bank to ease its stance (particularly considering the considerable time lags of monetary transmission).

08-OCT-08: PBC follows major central banks and lowers the benchmark interest rate by 0.27 percentage points to fight the financial crisis

After the concerted effort of major central banks to cut rates to calm the global stock markets and financial system, China followed and lowered its rate by 0.27 percentage points on Wednesday. This comes just three weeks after the last move in the rates on 15 September, Minimum reserve requirements will be lowered by 0.5 percentage points as of 15 October. In the new situation of the worsening crisis further cuts could be feasible. This is in stark contrast of the last months when the main concern of Chinese authorities was to fight inflationary trends in the economy.

15-SEP-08: PBC lowers the benchmark interest rate by 0.27 percentage points

After the pulication of the August 2008 inflation rate on 10 September, which was 4.9 per cent, the PBC made a surprise move to lower the benchmark one-year lending rate by 0.27 percentgae points today. The one-year lending rate now stands at 7.2 per cent. Additionally, the PBC lowered the minimum reserve requirements by 1 percentage point for all but the Big Four, the China Cmmunications and the Postal Bank.  This is the first lowering in minimum reserves since 1999.

The move has to be seen in connection to the turmoil in the global financial markets on this Monday. It is also a victory of the pro-growth fraction in China; recently, public debate was started on whether low inflation should be the main target of monetary policy in China. The quick change of the policy comes as a real surprise though: “This is a rapid change in stance: we had been expecting a gradual dismantling of lending quotas,” said Stephen Green, head of China research at Standard Chartered Bank in Shanghai in China Daily, a newspaper. It could be a dangerous one in an economy that is approaching a 7 per cent inflation rate over the whole year.

Concern over inflation fuel expectation to raise interest rates

After the pulication of the May 2008 inflation rate earlier this month, which was at 7.7 per cent, expectations to raise interest rates gained momentum towards the end of June. The rumours said that a increase in the interest rates was imminent, possibly over the weekend 28-29 June. While it is difficult to say where this information comes from, it had great impact on markets in the last days: China Daily headlined on  28 June “Shares plummet amid fear of interest rate hike” while Bloomberg wrote on 26 June “China’s Bonds fall on speculation central bank to raise rates“.

Michael Pettis of ChinaStakes.com provides an excellent analysis of the current situation: “If rumors of further interest rate increases can cause so much damage to the stock markets (and, I suppose, to the real estate markets), I am very skeptical about the ability of the PBoC to get approval actually to raise them further, as Governor Zhou seems to hope and has implied in recent comments. This may be a dangerous prediction to make, given all the rumors of an interest rate hike over the weekend, but I doubt the government has much appetite for further sharp declines in stock and real estate prices, especially so close to the Olympics.” He is right! Certainly, there are other instruments of monetary policy in China – such as window guidance! But pro-growth considerations should not rule out to use the full monetary policy tool box at hand to fight inflation.

“Serious short-term inflationary threat” calls for further tightening in China

After the publication of the latest inflation figures for January today (7.1 per cent) economists speculate of the extend of further tightening measures by the Chinese authorities. British newspaper “Telegraph” quotes Stephen Green from Standard Chartered Bank “that the [Chinese] economy faces a serious short-term inflationary threat”. His assessment makes him expect four rate hikes in 2008. American MarketWatch identified signs that as response to the rate-hike expectations the value of the USD went down immediately today (19-Feb-08). China’s Shanghai Daily refers to Ma Jun of Deutsche Bank who thinks two interest rate hikes within the next three months seem to be possible.

The same article quotes others, who think that scope for interest rate increases has diminished with the snow storms as the “interest-rate (…) is a weapon to fight inflation which will cast an impact on all industries”; this would not be the right prescription now as some sectors need particular support to weather the snowstorms. Instead of moving the benchmark interest rate, Li Maoyu of Changjiang Securities Company, argues that adjustments of the reserve-requirement ratio for banks and price controls were more likely.

Morgan Stanley’s Wang Qing, chief China economist, in an interview with Bloomberg, expects no re-action of the authorities to the January price hike as the short-term nature of the “supply shock” to food items induced by the snow storms early in the year does not call for immediate policy action.

I believe rate hikes indeed will be less pronounced in the next months as widely thought, given the danger of increasing capital inflows that would further add appreciation pressures for the RMB at a time when authorities already quickened RMB appreciation. Still, I expect drastic tightening measures, but mainly through the instrument of window guidance, a quantity-based direct instrument of the PBC. Since information on the scope of window guidance measures is scarce, one way to gauge whether window guidance is being intensified is the number of window guidance meetings that will actually be held in 2008 (2003: 3x; 2004: 1x; 2005: 1x; 2006: 6x; 2007: 2x). We will have to have a close eye on this.

CPI inflation in China: Widely expected to hit 7 per cent in January 2008

China is set to announce the January CPI inflation in a press release of the National Bureau of Statistics of China on Tuesday, 19 February 2008. Before that, analysts widely see the CPI to rise above 7 per cent, for the first time since December 1996. “Rumour says the rate is an 11-year high of 7.1 percent, which is also the median projection of a Reuters poll of 17 economists” (see also: Shanghai Daily, 14-Feb-08; and Banking Times, 14-Feb-08). As a result of this high CPI inflation in January, the central bank currently deliberates on necessary actions to be taken, particularly on raising the benchmark lending rate. Given the recent cut in interest rates in the US, however, this is unlikely to happen as it would fuel capital inflows further. Instead, this author sees further tightening mainly through the instrument of window guidance, a quantity-based direct instrument of the PBC, which has been increasingly employed by the central bank ever since 2004.