China Hikes Interest Rates Again

Despite slowing economy, central bank is still focusing on inflation

For the third time so far this year, China's central bank raised interest rates in an effort to quell inflation. Despite a slowing economy, the bank remains concerned about rising prices and their potential for unrest.

The new rates add 25 basis points to benchmark one-year lending rates, for a total of 6.56%, and also add 25 basis points to benchmark one-year deposit rates, for a total of 3.5%. The bank announced on its website that the new rates will take effect on Thursday.

China's economy, although slowing, has seen an inflation rate of 5.5% in May, a 34-month high. Beijing has been worried that excess liquidity and high inflation, with skyrocketing commodity and real estate prices, could lead to social disruptions, and has focused on reining in price increases through interest rate increases and rises in required reserve ratios for its banks.

Some economists believe that the policy may be nearing its end, since between tight money in China and less demand abroad, manufacturing is cooling down. Frederic Neumann, an economist at HSBC in Hong Kong, was quoted in the report saying, "China's inflation battle is almost at an end. Already, there are signs that price pressures are coming off. Today's rate hike may therefore have been the last in the cycle."

Another concern China faces, however, is the danger of raising rates too much. With U.S. interest rates almost at zero, high rates in China could draw an excess of foreign funds and reignite the excess liquidity problem that Beijing has been working so hard to fight. That could then spur further inflation, necessitating another increase in rates.

Wang Jun, an economist at CCIEE, a government think tank, said that inflation would be the determining factor. In the report he was quoted saying, "If inflation comes down, there will be no need to raise rates. But if prices rebound, there could be further rate rises."

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