China gears up for monetary tightening: First rate increase since 2007

Category: Global Economy Sub-category: World Economy
Document type: news


The People's Bank of China raised its key interest rates for the first time in three years, reflecting concerns about inflating asset bubbles. The benchmark rates were increased by 25 basis points, taking one-year deposit rates to 2.5% and one-year lending rates to 5.56%. This rate increase marks the beginning of a more aggressive phase of monetary tightening policies in the world's fastest growing major economy.

The impact of the rates increase was felt in markets across the globe, emphasizing China's role in driving the staggering global economic recovery. Oil and gold prices toppled, stocks turned negative in Europe, and the Dollar moved up.

Some analysts are of the opinion that the rate increase is suggestive of a deal between China and the US to strengthen the yuan and mellow down the worries about a currency war of competitive devaluations ahead of the upcoming G20 meetings. However, some analysts were of the contrarian view that higher rates will enable Beijing to rely less on currency appreciation and to keep the economy from staggering.

Finance ministers of the G20 major economies have been aiming to check currency strains and the issue will be of primary importance at the G20 leaders' summit to be held in South Korea in November.

In view of some, the time has come for China to embark on a more aggressive monetary tightening policy. The country has been relying on lending restrictions and banks' reserve requirements since a long time. According to Rob Subbaraman, an economist with Nomura in Hong Kong "Fundamentally, policy rates are just too low for an economy that's growing around 10 percent. To avoid bigger distortions, China needs to start moving rates to more appropriate levels".

A number of leading economists, including central bank advisors, have been urging an increase in deposit rates to keep savers' returns in the positive terrain. Consumer inflation was reported at 3.5% in the year to August and economists expect that the country's inflation climbed to 3.6% in September. China's third quarter GDP and other economic data are due to be reported soon and the current consensus forecast is that the country's economic growth slowed to 9.5% year over year in the last quarter, down from 10.3% in the second quarter.