Ouch!  Just as the stock markets seemed to be gaining some short-term confidence, the knock-out combination of terrible markets in the rest of the world and more fears of domestic interest-rate hikes (especially the latter) slammed China’s stock market rally today.  Yesterday’s sudden drop in bond prices had, I think, the biggest impact – there are rumors running around that the PBoC will raise interest rates as early as this weekend.

Until yesterday, with the market up 2.5% week to date, this was going to be the best week we’ve had in a long time, thanks mainly to the fuel price hike last Thursday evening which would allow the important energy sector to staunch their losses – but today the market dropped nearly 110 points in the first few minutes of trading and went on to lose another 60 points during the rest of the day, before a small rally in the last thirty minutes clawed back 25 points.  This left the SSE Composite down 5.3% for the day, at 2748, which adds up to a loss of 2.9% for the week, leaving the market one point lower than where it was before the fuel price hike was announced. 

I think there are at least two important implications of this week’s market performance that we need to consider.  First, I would imagine that the wind has been knocked out the sails of any investor who still thinks there is possible good news that can prop up this market in a sustained way.  What had seemed like a real rally, set off by an important fundamental change rather than yet another signaling move by the government (i.e. the partial removal of fuel price distortions), and encouraged by a slew of recent analyst reports arguing that the Chinese market was oversold and that it was now time to buy, fizzled out very quickly and very dramatically.  Even the growth in corporate profits, 20.9% year-on-year during the first five months of the year, has slowed, according to figures released today by the National Bureau of Statistics – they grew 42.1% a year earlier.  I think this week’s market only encourages the growing feeling that a rally is something into which you sell, sell, sell.  I suspect it is going to take an awful lot to bring back much conviction to the bulls.

Second, if rumors of further interest rate increases can cause so much damage to the stock markets (and, I suppose, to the real estate markets), I am very skeptical about the ability of the PBoC to get approval actually to raise them further, as Governor Zhou seems to hope and has implied in recent comments.  This may be a dangerous prediction to make, given all the rumors of an interest rate hike over the weekend, but I doubt the government has much appetite for further sharp declines in stock and real estate prices, especially so close to the Olympics.

Anyway, as I have mentioned several times in the past two weeks, it seems that power has once again shifted – this time back to the pro-growth camp, who are worried that China’s economy may be slowing down too sharply.  I have been told this week by a well-informed source that there will be no more references to economic overheating or to the "two prevents" in government statements about the economy, and although inflation continues to be an important concern, as far as the pro-growth camp goes the fight against inflation cannot be allowed to occur at the expense of growth.  

Unfortunately if this pro-growth concern rules out demand-constraining policies, like interest rate hikes, it doesn’t leave us with too many options.  I suppose the government will continue to use administrative measures to try to bring inflation down, but I am not very confident that they will work, so I guess we will have to wait until the inflation numbers get a lot worse before policies change again.

Meanwhile in today’s China Daily columnist Xin Zhiming, in an article which argued that "China, or Asia for that matter, can hardly be held responsible for rising inflation in the developed economies" (for some reason the Chinese authorities are inordinately worried about being "blamed" for global inflation, and are constantly insisting that it is not their fault), seems to acknowledge that inflation this year will be around 7%.  This is a big departure from the still-official target of 4.8%.  I think 7% is still too low a prediction, but at least government projections are becoming more reasonable.