Markets on alert for Chinese interest rate hikes

The warning by Chinese central bank chief Zhou Xiaochuan that China must be on “high alert” over fast-rising prices in the world’s second largest economy has raised the spectre of monetary tightening by the People’s Bank of China (PBOC).

Zhou’s warning, at a key news conference held during the country’s parliament, came a week after Beijing reported year-on-year inflation of 3.2% in February, marking a 10-month high. Food prices spiked 6% over the same period.

“In the past, some of us thought it was no big deal if inflation was a little high,” the PBOC governor noted, adding: “International experience and our own experience here show that this thinking might not be correct.”

Zhou’s comments raise the likelihood that China will seek to tighten monetary policy as the year develops, in an attempt to suppress price rises at a time when broader economic growth is slowing. Official figures show the mainland economy expanded by 7.8% in 2012, the slowest pace in more than a decade.

The PBOC would not be drawn on when interest rate hikes could be expected, but analysts pointed to a series of hikes, most likely early in the second half of the year. “Policy is clearly going to tighten going forward,” said Zhang Zhiwei, chief China economist at Nomura. “Mostly likely we will see the tightening process start to accelerate in the second quarter, with two interest rate hikes in the second half, each about 25 basis points (bps).” The PBoC surprised many in June 2012 by cutting the benchmark one-year lending rate by 25 bps, to 6%.

Many see inflation continuing to inch up as the year progresses, without spiking to dangerous levels. “I see no reason to believe that 2013 will be that different [from government projections],” Jim O’Neill, the outgoing chairman of Goldman Sachs Asset Management, told Emerging Markets. O’Neill tips inflation to hit 3.5% by year-end, with economic growth easing to 7.5%.

Beijing fears more than rampant inflation: throughout Chinese history it has often proved the trigger for serious social unrest. There seems little threat of that now but Zhou’s hawkish tone was a clear sign of China’s determination to keep a lid on prices before they spiral out of control. “It pays to respect what [China’s leaders] say they are focused on because it is usually true,” said O’Neill.

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China has another motivation for suppressing inflation, according to analysts: with a new generation of leaders sworn in, headed by president Xi Jinping, Beijing wants the political transition process to go as smoothly as possible.

Nor is China the only major emerging-market economy facing a concerted battle against rising costs. In India, retail inflation hit 10.9% in February, rising for the fifth month in a row, on the back of higher food costs while in Russia consumer prices rose 7.3% year-on-year in February, up from 7.1% in January.


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