When China's central bank cut interest rates across the board three months ago, mainland investors pre-empted the move by bidding up stock prices in Shanghai and Shenzhen. So when the investors piled into the markets yesterday, betting that a second round of cuts would be announced tomorrowand effective from Monday, nobody ignored the implications of the surge in equities. UBS Securities (Hong Kong) economist Qu Hongbin said: 'If you look at the turnover in Shenzhen and Shanghai, these guys are pretty serious.' A second rate cut is widely expected for political and economic reasons after the first reduction on May 1 and its timing hinges on Beijing's progress in containing its inflamed economy. Judging from the latest retail price index (RPI) figures, it is time for a cut to salvage the ailing state sector and buoy state banks' profitability. The index for July, which was announced two weeks ago, rose 5.8 per cent compared with the year-ago month. A Beijing economist, who has been calling for a further rate cut on expectations that inflation would trend lower, said: 'Basically, the bank can cut the rates anytime after the price index is released.' He said China's real interest rate was exceptionally high and provided room for a second reduction. On one-year deposit rates, which stand at 9.18 per cent, the real interest rate exceeds 3 per cent when compared with the July RPI. This has put a heavy burden on state banks and enterprises. 'If the central bank can cap the real interest rate at 1.5 per cent, it will lighten their burden,' he said. Although there was a risk inflation would pick up during the rest of the year, UBS's Mr Qu did not expect a significant rebound. 'China still has a good chance to achieve its 10 per cent inflation [RPI] target,' he said. Hongkong Bank China Services research manager Benny Chiu is not convinced, however. He said the consumer price index (CPI), which includes price changes services, was more relevant in calculating the real interest rate as it reflected conditions more accurately. The CPI rose 8.3 per cent last month, a similar pace to the one-year deposit rates, which gave little room for a second rate cut, he said. 'I don't see the [August CPI] index substantially lower because of inflationary pressure from rising prices on service items,' Mr Chui said. Cutting nominal interest rates would also go against market forces, which had pushed black-market lending rates above official rates, he said. A rate cut would be more feasible on the deposits side, he said, because of the rapid growth of household savings. These soared almost 39 per cent at the end of June from a year ago. Most market talk suggests a larger cut than the first. Deposit rates will be slashed by an average of 1.5 percentage points, while the lending rates will be trimmed by 1.2 percentage points. In May, the People's Bank of China cut deposit rates by an average 0.98 percentage point and lending rates by 0.75 percentage point.
