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Analysis:China Rate Hike To Help Depositors, Curb CPI/Lending

Published Wednesday, 20th October 2010 01:02 am - © 2010 MNI News

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BEIJING (MNI) - The People's Bank of China took the markets by surprise Tuesday with the announcement of the first interest rate hikes in nearly three years, a move which is designed in part to ease the burden of long-suffering bank depositors.

Analysts interpreted the increases as a vote of confidence on the part of Beijing about the state of the domestic economy.

The increases will see benchmark one-year deposit and lending rates increased by 25 basis points each on October 20.

Further out the curve, however, lending and deposit rates will be subject to adjustments of differing magnitudes. Rates for five-year deposits will rise by 60 basis points to 4.2%, for example, but the equivalent lending rate only rises 20 basis points.

The asymmetric nature of Tuesday interest rate adjustments suggests that the government is attempting to tackle the current negative real interest rates borne by consumers, analysts said.

"Beijing is still concerned about the ... burden of borrowers and the economic recovery," said Ting Lu, an economist with BofA Merrill Lynch, in a note to clients.

The bigger increases for longer-term deposits suggests that the government wants to maintain liquidity in the banking system while dealing with rising inflation expectations, he said.

The adjustments also mean a squeeze on net interest margin for the banks, their main source of profitability. China's efforts towards a post-crisis clean-up have focused on the staggering CNY9.6 trillion in new loans lent out last year and continued strong lending growth this year, and the undoubted costs of such a lending boom.

The domestic bond market was rife with talk in late summer and early fall that the government would adjust the ceiling that it mandates on deposit rates in a bid to force banks to increase their operational competency.

Although there was no indication Tuesday of a comprehensive reform of deposit rate ceilings, the differing magnitude of the adjustments to deposit and loans rates of three years and above will mean higher capital costs and a narrower net interest margins for banks.

The five-year margin, for example, will narrow to 176 basis points post-adjustment versus the current 216 points.

Tuesday's rate hikes follow the central bank's move last week to raise the deposit reserve requirement for six banks -- including the "big four" state-owned lenders -- freezing an estimated CNY185 billion in interbank liquidity. This led some analysts to conclude that the PBOC's move was targeted at continued strong bank lending growth.

Mark Williams, an economist with Capital Economics in London, said in a note that excessive lending likely pushed the PBOC to act, but that it had to wait until after a key Communist Party meeting that concluded Monday.

Still, inflation remains the government's more immediate concern, with the National Bureau of Statistics is scheduled to release the latest consumer price inflation readings on Thursday morning.

The consumer price index rose to 3.5% in August from 3.3% in July, while economists are expecting it to have risen to 3.6% in September, according to a survey of forecasts compiled by Market News International.

That's above the government's full-year inflation target at around 3%, pushing real deposit rates firmly into negative territory. Tom Orlik, an economist with Stone & McCarthy Research Associates in Beijing, said that headline CPI is set to ease in the coming months as food prices -- the swing factor in Chinese inflation trends -- come down.

"It's a surprise that (the rate hike) happened now but I think it's because growth is stronger than expected," he said.

Economists surveyed by Market News expect the government to report that the economy expanded by 9.4% y/y in the third quarter, down from the second quarter's 10.3% increase.

Although Beijing has resisted increasing rates until now, it hasn't stood pat on policy since the dramatic monetary and fiscal easings of late 2008. Government agencies have been working to control the banking system after the record CNY9.6 trillion in new loans extended last year.

The screws have been tightened on the property market, too, including successively higher mortgage and downpayment requirements and plans to introduce a property tax as early as the start of 2011.

While analysts continue to debate the efficacy of interest rate adjustments in managing Chinese domestic economic activity, the government has shown a sensitivity to using them owing to the hawkish signal that they send to the market.

Royal Bank of Canada told clients to expect increases totaling 50 basis points in 2011 "as part of the government's efforts to unwind some of the extraordinary measures put in place during the financial crisis."

The yuan will rise to 6.60 against the dollar by year-end, RBC forecast, and to 6.20 by December 2011.

beijing@marketnews.com ** Market News International Beijing Newsroom +86-10 5864 5241**

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