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Central bank targets inflation

By Yi Xianrong (China Daily)
Updated: 2010-12-28 08:06

Unexpected increase in interest rate should help contain the soaring prices and real estate bubble in the new year

The latest interest rate hike announced by the People's Bank of China highlighted the government's grave concern over soaring prices and its determination to contain the real estate bubble.

China's central bank decided on Saturday to increase the one-year benchmark lending and deposit interest rates by 25 basis points from the next day, the second increase this year.

Although there had previously been strong calls for rate increases in the context of the consumer price index (CPI) growth rate continually hitting a new high, Saturday's move was still beyond expectations. All previous messages transmitted by the country's central bank, including its decision on Dec 10 to raise commercial banks' reserve requirement, had suggested new interest rate hikes would be unlikely before the end of the year.

The rate hike was announced on the day when the United States and European countries were enjoying their Christmas holidays and their investment banks were unable to make a timely response.

The unexpected move showcased the central bank's intention of preventing its effects from being discounted because of possible advance market expectations. Giving days for Western countries to digest the possible effects of China's move should also help minimize the repercussions on the international financial markets.

As far as China's domestic market is concerned, the decision to raise interest rates again before the new year will help China stabilize inflation expectations next year. It will also help curb domestic property price bubbles.

The series of policies and measures adopted by the relevant State departments over the past months have curbed the momentum of soaring prices. It is expected that the CPI growth rate in December will fall from the 5.1 percent of November, which was a record high over the past 28 months.

Such a high-level CPI growth rate will obviously be unfavorable to the national economy next year, which is the starting year of the 12th Five-Year Plan period (2011-2015). It will also pose an enormous challenge to the country's economic restructuring and industrial upgrading drives.

However, in the absence of a long-term effective price stabilizing mechanism, the effects achieved by the temporary and emergency administrative means will soon subside and the momentum of price rises is likely to rebound at a time when the country's excess liquidity has not been fundamentally changed.

The rate hike will not affect China's stock market very much because investors, after weeks of uneasiness about such rumors, can now sigh with a relief that it is mild. And the hike is actually good news for the stock market because it means the economic fundamentals are getting better and industrial performance is improving.

As the top State organ in charge of the country's monetary policy, the People's Bank of China should put how to curb soaring prices and real estate bubbles firmly at the top of its agenda.

Despite encountering a new round of rigid macro-regulatory measures from the central government over the past months, domestic house prices have stood very firm and there is still a possibility of further rises if no effective measures are taken. Any rebound in prices will increase the difficulties facing the central government in regulating the long-controversial sector next year.

The over-fast growth of the domestic real estate market has been the result of the country's unusual monetary policy since the start of the global financial crisis. The latest rate hike indicates the central bank's resolve to restore the emergency monetary policy to normal and bring the red-hot real estate market back onto the track of healthy development.

Despite being downplayed by some, a 0.25 percent increase in interest rates will play an inestimable influence on the real estate market. It will not only increase speculation costs in this sector, it will also change investor expectations of the future market. Any fundamental changes in investor expectations will change the trend of China's speculation-prone real estate sector.

More importantly, the latest rate hike is expected to produce an accumulated effect on the domestic real estate market, one that heavily depends on credit. For a real estate market in which the down payment practice is widely applied, any rate hikes will increase the cost of borrowing and thus deter some from entering the market.

The interest rate hike indicates that the central bank's "prudent" monetary policy will be fully implemented by not only controlling credits but also by readjusting interest rates. These will have a relatively big impact on the domestic real estate market.

The market should not underestimate the potency of the prudent monetary policy.

The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.