Case for mainland rate rise grows

PUBLISHED : Wednesday, 13 June, 2007, 12:00am
UPDATED : Wednesday, 13 June, 2007, 12:00am

Expect the mainland to raise interest rates any day now.

After the release yesterday of inflation and money supply data for May, more interest rate increases look inevitable and they are likely to come sooner rather than later.

Last month the mainland's consumer price inflation hit 3.4 per cent, the highest rate in more than two years.

The increase over April's 3 per cent was driven almost entirely by food prices, which rose 8.3 per cent year on year. In turn, that rise was driven by steep increases in the price of eggs - up 37.1 per cent - and meats - up 26.5 per cent.

Those increases were the result of an earlier rise in the price of grain used for animal food, exacerbated by the recent outbreak of blue ear disease in pigs, which has pushed up pork prices by more than 40 per cent over the past 12 months.

Because last month's rise in inflation was restricted to food prices, which are often volatile, while the prices of other goods and services were relatively stable, some analysts argue that there is no need for the mainland authorities to raise interest rates aggressively.

For example, in a note sent to clients on Monday, Frank Gong, head of China research and strategy at JP Morgan, advised that 'an expected uptick in agricultural product price inflation will not necessarily lead to a rate hike'.

And yesterday, Qu Hongbin, chief economist for China at HSBC, told his clients that 'inflation is still not a big problem in China'.

'The recent surge in food and pork meat prices is a supply shock, so the real solution is not aggressive monetary tightening,' he argued.

If rising food prices were the only problem faced by China, they might be right. Unfortunately there are other factors which make an early rate rise likely.

For one thing, May's increase in consumer prices means that the inflation rate has once again overtaken bank deposit rates. In other words, the purchasing power of savings kept on deposit in banks is diminishing.

That decline in value provides an additional incentive for mainland savers to withdraw their money from the country's banks and gamble it in the over-heated A-share market.

Last month individual depositors withdrew a massive 278.4 billion yuan from their bank accounts, on top of the 167.4 billion yuan they took out in April. Much of that money has gone straight into stock speculation, magnifying the probability of a painful crash at some point in the future.

In addition, while underlying non-food inflation was relatively stable in May, it might not stay that way. Last month China's M2 money supply rose 16.7 per cent. Although the increase was a touch slower than April's 17.1 per cent, it was still higher than the government's target rate of 16 per cent, raising the risk of a future increase in inflation.

So, although the rate of food price increases may well ease over coming months, it is likely that mainland authorities will decide it is better to be safe than sorry and opt to push ahead with interest rate increases sooner rather than later.