What made China raise rates?

The surprise move is causing a ripple effect in markets worldwide.

By Jim J. Jubak Oct 19, 2010 4:21PM

Jim JubakChina caught global financial markets flatfooted Tuesday by raising its benchmark interest rates for the first time since 2007.

The People's Bank of China raised its one-year lending rate to 5.56% from 5.31% and its deposit rate by 0.25 percentage points to 2.5%.

The move sent markets lower around the world. The Dow Jones industrials were down 2% at 3:30 ET. In Europe, the FTSE 100 was down 0.7%, and Brazil's Bovespa was down 1.6%.

The timing of the rate increase has set off rampant speculation. China almost never changes its benchmark rates, preferring moves such as raising bank reserve requirements as the People's Bank did last week. So why raise the benchmark rate now?

One theory holds that inflation numbers for September -- due for release later this week -- will show an increase to 3.6%. The People's Bank moved today to show that it's ahead of the news.

A second theory suggests that the bank's move is tied to third-quarter GDP figures, which are due to be released later this week. Economists are expecting a 9.5% growth rate, but this theory says the bank may have raised rates because growth will exceed expectations.

Another theory says that the benchmark increase is a reaction to news that new bank lending in September rose and now threatens to exceed the government's quota for 2010. (See this post for more on that.) And in reaction to a soaring Shanghai stock market that's now 27% off its recent lows.

Still another theory says that the benchmark increase is a sign that China and the U.S. have reached a deal on allowing China's currency, the renminbi, to appreciate at a faster rate.

And yet another theory says that the increase in the benchmark is a sign of no deal since the increase itself will work to drive the renminbi higher without any formal agreement.

One thing that isn't surprising is the timing of the increase. Earlier this month, bank governor Zhou Xiaochuan said that tools such as raising reserve requirements were sufficient to control inflation. Today's about face from that position is the kind of big change in policy that often follows one of the Communist Party's big meetings.

The annual party congress ended yesterday. (For more on what was on the agenda at the party meeting, see this post.)

Jim Jubak doesn't own shares of any company mentioned in this post in his personal portfolio. 

Oct 20, 2010 2:31PM
Wonder why there are no jobs in America? Read this article. "The US Chamber of Commerce holds seminars with Chinese Gov. officials to teach American firms how to outsource." Article by Paul William Tenny. I would have posted the url but it was blocked by Jubak's Journal.
Oct 20, 2010 12:54PM

$1.50/hour in Asia.


Wages are on the increase in Asia.  What is often lost in discussion is the fact that factory workers are also supplied a room, food and clothing (uniforms).  Probably not lavish.  But, most of their income is in fact, discretionary.


This is not true in the American factories that I've worked over my life.  Most are now closed.

Oct 20, 2010 12:47PM

Raising the interest rates in the world's fastest growing economy is not going to have any measureable impact in China.  It would take several moves of this size to really matter, if inflation was really a concern for the Chinese.


The fact that it coincided with Geitner's defense of the dollar, smacks of a deal.  We will probably get token appreciation of the Remnimbi in time for the November elections.

Oct 20, 2010 9:26AM
Jim, please, theory, theory, theory, answer your question.  Could the CAUSE of the rate increase be the result of the Federal Reserve pushing down the value of the Dollar by 7% in the past few months?  What is the RESULT?  Will this cause inflation in China and inflation in the US import prices?  Will the higher rates result in a loss of yet more investment capital in the US?  Do our idiot politicians realize we can not print our way out of debt nor gain exports in a battle against $1.50 hour labor in China? 
Oct 20, 2010 1:41PM
Buy China stocks. Lose your bias and make some money instead. This is a giant in the making and no turning back. Or you can buy Apple, thanks to the iphones, ipads, and imacs made in China and unsurpassed quality and craftsmanship. 
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