China raises key rate for 1st time since crisis

AP News
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Posted: Oct 19, 2010 4:18 PM
China raises key rate for 1st time since crisis

China raised its key interest rate Tuesday for the first time since the global crisis. The move is intended to control inflation and rapid growth even as other Asian economies move to keep their recoveries on track.

The rate hike, China's first since 2007, reflected Beijing's focus on guiding growth to a more sustainable level rather than revving up the economy. China's economy grew 10.3 percent in the second quarter.

The People's Bank of China, the central bank, might have felt forced to act after bank lending surged in September despite government orders to control credit, said economist Mark Williams of Capital Economics in London.

"I suspect the People's Bank feels it needs to give a strong signal to banks that this has to stop," said Williams.

China's surprise move to raise interest rates rattled Wall Street. The Dow Jones industrial average fell 165 points to close below 11,000 for the first time in a little more than a week.

The rate on a one-year loan was raised by 0.25 percentage points to 5.56 percent effective Wednesday, said the central bank. The one-year rate paid on deposits was raised, also by 0.25 percentage points, to 2.5 percent.

China's rapid growth has powered the global economy's recovery from a deep recession, even as the United States and Europe have struggled to return to firmer economic footing.

By contrast, the U.S. is trying to speed up its weak expansion. The Federal Reserve is widely expected on Nov. 3 to launch a program to buy more Treasury bonds. The goal would be to drive down interest rates on mortgages, corporate loans and other debts. If cheaper loans prod Americans to boost spending, then the U.S. economy _ the world's largest _ would strengthen.

During the global recession, most central banks acted in concert to try to stimulate growth. But countries have emerged from the recession at different speeds, underscoring the unevenness of the global recovery. That's why individual central banks have taken varying steps to serve their economies.

Australia's central bank raised interest rates six times beginning in October. More recently, it's held rates steady, citing Europe's debt crisis. South Korea also was expected to consider a hike but has kept its key rate steady.

Canada has left its key rate alone after three rate increases. India, however, has raised rates five times to control inflation and is expected to boost them yet again.

Earlier this month, the European Central Bank left its key rate alone. But Japan cut its rate to near zero to inject life into its stagnant economy and battle deflation.

The quarter-point bump-up in China's loan rates is unlikely to slow China's economic growth very much. That would be good news for the U.S. and other countries that sell goods there.

"It's like a mosquito biting an elephant," Jay Bryson, global economist at Wells Fargo, said of China's small rate increase.

The value of the U.S. dollar surged Tuesday on China's rate news. But analysts don't think that spike will last. More important, they say, is if Beijing is trying to use its rate decision to signal that it will let its currency rise in value. Many in the U.S. complain that China keeps its currency artificially low, driving sales of its imports to the United States but hurting U.S. exports sold in China.

If China lets the value of its currency rise further, U.S. exports would become cheaper and thus more attractive to foreign buyers. The United States has been prodding Beijing to act.

The timing of Tuesday's announcement also might have been dictated by the Chinese political calendar.

Communist Party leaders wrapped up a major meeting Monday aimed at crafting an economic blueprint for the coming five years. They might have wanted to delay new of a rate hike to keep any negative reaction by Chinese financial markets from overshadowing publicity about the gathering.

China rebounded quickly from the global crisis on the strength of a 4 trillion yuan ($586 billion) stimulus and a flood of lending by state banks. Easy credit fueled a surge in real estate and stock prices, prompting Chinese regulators to tighten controls earlier this year as other economies were still struggling with recession.

Last week, major Chinese banks were ordered to increase reserves in a move to shrink the pool of money for credit, according to Chinese news reports. They said the move might have been prompted by the credit surge, which saw bank loans made in September jump 10 percent from August's level.

The government says banks will be allowed to lend a total of 7.5 trillion yuan ($1.1 trillion) this year, down from a record 9.6 trillion yuan ($1.4 trillion) in 2009. Bank lending has been rising in recent months at a rate of 18 percent over the previous year.

Analysts said last week's move, instead of a rate hike at that time, suggested the central bank faced opposition to an across-the-board increase from Chinese leaders who worried it might derail growth. Chinese leaders have warned that despite its robust expansion, the country faces uncertain global conditions.

Beijing also is trying to control steadily rising inflation that hit 3.5 percent in August _ above the official annual target of 3 percent. Analysts believe September inflation, due to be reported Thursday, rose still further.

"The fact that inflation has been rising does provide some cover for the People's Bank to raise rates if they thought they were too low," Williams said. "It's easier to raise rates when inflation is rising than when it is falling."

Higher interest rates in China might attract more inflows of speculative "hot money" that regulators worry might be fueling a dangerous bubble in stock and real estate prices. Beijing has tried to block such flows, and analysts suggested earlier that might have been a reason for delaying a rate increase.

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AP Economics Writer Jeannine Aversa in Washington contributed to this report.