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‘Heavy Lifting’ Looms as China Rate Below Inflation

China’s central bank will likely need to increase interest rates further in coming months as the three moves since mid-October leave household wealth being eroded by accelerating inflation.

The People’s Bank of China yesterday raised the one-year lending rate by a quarter point to 6.06 percent and the one-year deposit rate an equivalent amount to 3 percent. The deposit rate remains almost 2 percentage points less than the pace of consumer-price gains, giving savers an incentive to buy goods and assets.

“There is still a substantial amount of heavy lifting to do in terms of rates -- at this stage of the cycle, the fact that we still have negative real rates is quite alarming,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong and a former adviser to Australia’s government.

Premier Wen Jiabao’s government has yet to return rates to pre-crisis levels, seeking to sustain the economy’s rebound to growth of about 10 percent. With overheating a danger in the first half of the year, policy makers are likely to raise their benchmarks further, order banks to set aside more cash as reserves and let the yuan appreciate to stem price pressures, Wang Qing, a Morgan Stanley economist in Hong Kong, wrote in a note yesterday.

Yuan Climbs

Interest-rate swaps jumped. The benchmark Shanghai Composite Index of stocks fell 0.9 percent. The yuan closed unchanged at 6.5938 per dollar in Shanghai, after earlier advancing as much as 0.2 percent.

“The economy has been growing too fast” and policy makers are “behind the curve,” Andy Xie, an independent economist who previously worked for Morgan Stanley, told Bloomberg Television in Hong Kong today.

China’s rates remain 2.5 percentage points lower than they should be amid rising labor, energy and food costs and a “huge bubble” in the property market, he said.

The central bank moved on the last day of a week-long holiday and before a report next week that may show consumer prices rose 5.3 percent in January, according to the median estimate in a Bloomberg News survey of economists.

That pace is still slower than the most recent inflation rates in Group of 20 nations including Brazil, Russia, India and Argentina, where consumer prices rose 10.9 percent in December from a year earlier.

Extra ‘Anxiety’

“A rate rise was expected, but given they delayed to the end of Chinese New Year, it created anxiety over the potential severity,” said Gavin Parry, managing director of Parry International Trading Ltd. in Hong Kong. “Now that uncertainty is removed, the markets can focus on the January trade, and the producer prices and consumer-price data next week.”

Government figures expected next week are also forecast to show export growth accelerated in January and producer prices advanced at a faster pace, according to Bloomberg surveys.

Shanghai’s stock index has lost 5.9 percent over the past year, in part on concern at the impact of policy makers’ efforts to defuse a property-market bubble after record lending. The MSCI Asia Pacific Index climbed 21 percent in that time by comparison.

A drought that’s threatening grain output and a New Year surge in lending are adding to inflation risks after money supply jumped more than 50 percent in two years. Economic growth accelerated in the fourth quarter to a 9.8 percent annual pace.

Premier’s Campaign

Besides increases in rates and banks’ reserve requirements, Wen’s campaign against inflation spans sales of state-food reserves, subsidies for low-income earners, and crackdowns on speculation and hoarding.

China’s 0.75 percentage point of increases in one-year rates since the global financial crisis compare with India raising borrowing costs seven times for a total of 1.75 percentage points. In South Korea, where policy makers meet this week to decide on rates, borrowing costs climbed 0.75 percentage point so far.

Isaac Meng, a Beijing-based economist for BNP Paribas, said yesterday that he expected “accelerated tightening,” with rates rising by as much as another 1.5 percentage points. Before the financial crisis, the one-year lending rate was 7.47 percent, 1.41 percentage points higher than the level taking effect today.

In yesterday’s move, the central bank raised long-term rates for deposits by more than for loans. For savers, the increase was as much as 45 basis points, for five-year deposits.

McDonald’s, Starbucks

“The goal is to encourage savers to keep their money in bank deposits rather than shifting to equities or property,” said Mark Williams, a London-based economist at Capital Economics Ltd.

Companies from Baoshan Iron & Steel Co. to Starbucks Corp. and McDonald’s Corp. have raised prices. While wages are also climbing, Chinese consumers are more concerned about inflation than at any time in the past decade, according to a central bank survey released in December.

China’s government aims to hold inflation at 4 percent this year, state broadcaster CCTV reported in December. Officials also want to limit the risk of property bubbles in an economy awash with cash.

China’s foreign-exchange reserves, the world’s biggest, climbed by a record $199 billion in the fourth quarter to $2.85 trillion, and banks extended 7.95 trillion yuan ($1.2 trillion) of new loans last year, exceeding the government’s targeted maximum of 7.5 trillion yuan.

‘Ugly’ Number

New lending may have surged to 1.2 trillion yuan in January, according to the median estimate in a Bloomberg News survey of analysts. In December, the amount was only 481 billion yuan, a difference that highlights a pattern of banks lending more at the start of each year.

The government knows January’s inflation number will “look ugly” and wants to be seen as acting in the lead-up to the annual meeting of the National People’s Congress, the country’s lawmaking body, in early March, said Ma Jun, Deutsche Bank AG’s chief China economist.

Inflation is largely being driven by food costs. China’s State Council said it would do more to ensure stable grain production, including by raising minimum purchase prices for rice, state radio reported today.

Drought hitting parts of the country may cut grain output and undermine efforts to stabilize prices, Premier Wen said last week.

Last month, a jump in consumer spending ahead of the Lunar New Year holiday and bad weather that damaged crops may have contributed to a higher inflation reading.

--Li Yanping, Shamim Adam, with assistance from Darren Boey, Michael Munoz, Jay Wang, Kristine Aquino and Susan Li. Editors: Paul Panckhurst, Josh Fellman.

To contact the Bloomberg News staff on this story: Li Yanping in Beijing at yli16@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at ppanckhurst@bloomberg.net

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