February 08,2011

China Raise Interest Rates to Combat Inflation Expected to the New High

By CSC staff, Shanghai

China raised interest rates for the third time since mid-October ahead of a report forecast to show inflation accelerated to the fastest pace in 30 months.

The benchmark one-year lending rate will increase to 6.06 percent from 5.81 percent, effective tomorrow, the People's Bank of China said on its website today. The one-year deposit rate will rise to 3 percent from 2.75 percent.

According to the January Data Preview by the research team of Morgan Stanley, trade and monetary data are due on Feb 10 and 11, respectively. However, according to the NBS's release schedule, only inflation figures will be reported on February 15 while industrial production, fixed asset investments and retail sales will be reported with the February release in March. For January dataset, market attention will center on headline CPI and new loan creation to judge the inflation pressure and policy evolution, in our view.

Inflation-CPI may have rebounded to new high: CPI softened to +4.6% YoY in December (vs. +5.1% YoY in Dec) due to the phasing-out of the carryover effect and alleviation of food inflation. However, the carryover effect surged to 4ppts in January. Food inflation may have rebounded noticeably as the result of seasonal effect of Chinese New Year and bad weather (icy rain in Southern China and heavy drought in Northern China) according to the high-frequency price release by Ministry of Commerce and NDRC. In the mean time, the escalated tightening on property sector (removal of the favorable mortgage rate for the purchase of the first home) may have continued to drive up the "Residence" component which is the primary contributor to non-food inflation. Against this background, we believe headline CPI may have rebounded to +5.2% YoY in January to record the new high of this round of the inflation cycle. After seasonal adjustment, CPI is estimated to grow +0.4% MoM in January (vs. +0.1% sa MoM in Dec). Buoyed by the escalation in international commodity prices as the result of robust demand from EM economies and better-than-expected recovery of DM countries, we believe PPI inflation may have rebounded to +6.2% YoY in January (vs. +5.9% YoY in Dec). If January CPI comes in line or surprises on the upside, we expect the first rate hike in 2011 to be just around the corner to manage the heightened inflation expectation.

Monetary ?Seasonal Surge of New Loan Creation: More than RMB 1 trillion in new loans was reported to be extended in the first two weeks of January. While the surge of new loan creation in January was nothing strange under the loan quota system (RMB 1.39 tn in Jan 10, RMB 1.62 tn in Jan 09, and RMB 803 bn in Jan 08), it is unacceptable when the PBOC is adopting a "macro prudence" regulatory framework against the backdrop of monetary policy stance shifting from "moderately loosening" to "prudent" and controlling inflation having been put into a more prominent position. This explained the unexpected RRR hike announced on Jan 14, which was interpreted as a response from the PBOC to highlight its policy stance and defend its authority. Although some banks stopped making new loans in the second half of January due to liquidity shortage and fear of potential penalties (such as Dynamic Differentiated RRR - see China Economics: Dynamic Differentiated RRR Adjustment to Become a Primary Monetary Policy Tool, Jan 10, 2011), we estimate that up to RMB 1.2 tn of new loans may have been made in January. However, loan growth may decline to +18.7% YoY (vs. +19.9% YoY in Dec) as the result of high base effect (RMB 1.39 tn of new loan in Jan 10). Given the accumulated tightening effect from the continued RRR hikes which may have reduced the monetary multiplier noticeably, we envisage that M2 growth may have slowed to +19.2% YoY in January (vs. +19.7% YoY in Dec).

Trade ?Robust export and import growth: Although monthly shipment value may have fallen seasonally after the phase-out of the Christmas & New Year peak season, the better-than-expected recovery in DM economies led by US may help an upbeat export growth on year-over-year basis in January. In addition, in light of the disruption of the week-long holiday of Chinese Lunar New Year (Feb 2-9), exporters may have speeded up deliveries in January. We expect export growth may have rebounded to +22.5% YoY in January (vs. +17.9% YoY in Dec). Given strong domestic demand and accelerated shipment before Chinese Lunar New Year, we expect import growth to have rallied to +29.4% YoY in January (vs. +25.6% YoY in Dec). As a result, the trade surplus may have dwindled to US$ 10.7 bn (vs. US$ 13.1 bn in Dec).

 (The research team of Morgan Stanley contributs to the piece.)


Click to Get New TextCan't read this text? Please click the image!
Please verify the text in the image.