Odds for China Interest Rate-Increase Higher on Inflation Risk, Aviva Says
China may raise interest rates twice before the end of the year and tolerate currency appreciation to slow inflation from a two-year high, according to Aviva Investors, a unit of the U.K.’s second-largest insurer.
The People’s Bank of China can afford to increase borrowing costs to douse inflation without the risk of attracting an influx of cash because it has greater control of its capital account, said Peter Monson, a London-based analyst at Aviva Investors, which manages about $8 billion of emerging-market stocks and bonds. The yuan may advance 2 percent against the dollar by the end of June as part of policies to help counter higher costs of imported goods, he said.
“The PBOC needs to increase the pace of rate hikes to help manage inflation expectations which have surely shot up over the past week or so,” Monson, who tracks currencies and banks in developing economies, said in an interview late yesterday. “The probability of a 50 basis-point hike before year-end has definitely risen.”
China’s cabinet yesterday said it may impose temporary price controls on “important daily necessities” and production materials. A statistics bureau report on Nov. 11 showed inflation accelerated to 4.4 percent in October from a year earlier, the fastest pace since September 2008.
The central bank on Oct. 19 unexpectedly raised the one- year lending rate by 25 basis points to 5.56 percent, and lifted the deposit rate by the same margin to 2.5 percent. Governor Zhou Xiaochuan also boosted banks’ reserve-requirement ratio, after a record 9.6 trillion yuan ($1.4 trillion) credit boom in 2009 helped propel China past Japan as the world’s second- largest economy.
Capital Inflows
Two-year interest-rate swaps, which exchange the one-year official savings rate for a fixed payment, climbed 72 basis points since Oct. 19 to 3.20 percent, implying traders are pricing in more than a full percentage-point increase in the deposit rate in a year.
“There is a strong chance we will get two rate hikes before year-end to help stem credit growth and to manage expectations,” Monson said. “In addition, I think there will also be further reserve hikes. Another tool is that allowing yuan strengthening would help subdue inflation from imported raw materials.”
Yuan Appreciation
The yuan has appreciated 2.8 percent since June 19 after the central bank ended a two-year peg to the dollar. It traded at 6.6415 as of 12:30 p.m. in Hong Kong, according to the China Foreign Exchange Trading System. The currency may climb to 6.60 by year-end and to 6.5 by June, Monson said.
“Yuan appreciation will continue, given that China has greater control of its capital account,” he said. “This enables the PBOC to maintain control over the renminbi fix. It means China can continue to increase rates without the same concern on capital inflows that most emerging markets are struggling to deal with.”
Investors plowed $13.8 billion of cash into equity funds dedicated to China this year through Nov. 10, the single largest recipient by country, Barclays Capital Plc wrote in a Nov. 12 report, citing EPFR Global data. The amount is equivalent to a 32.2 percent share of inflows to Asia.
To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net.
To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net.
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