Another Chinese rate-hike

(09.02.2011) The rate-hike in China gained attention on a day without any significant macro releases. The news generated some market jiggery immediately, but the movements were reversed fairly quickly. In FX, the Norwegian krone weakened somewhat versus both the euro and the US dollar.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

DNB markets' dealingroom in osloThe People’s Bank of China (PBoC) announced around noon yesterday that the benchmark interest rates will be hiked with effective from today. Since the PBoC never holds preannounced policy meetings, any change in their monetary policy always comes somewhat surprising. Still, this time it was widely expected that a rate hike was imminent.

The benchmark one-year deposit and loan rates were both raised with 25 basis points, towards 3.00 per cent and 6.06 per cent, respectively; well in line with the gradual tightening process that began in October, and which has since then led to 4 rate hikes (incl. yesterday’s) and 5 hikes in the required reserve ratio.

The monetary tightening comes at the backdrop of the recent surge in headline consumer price inflation – from 2.9 per cent in June to 4.6 per cent in December. Another likely factor is the government’s difficulties in curbing the massive loan growth from the banks. As a consequence of the rate hike, many now speculates that the inflation figure for January, which according to Reuters is scheduled for release next Tuesday, will unveil a new top in the price growth.

So far, the increase in the inflation rate has been caused mainly due to higher food and energy prices. Admittedly, core inflation – as measured by CPI ex. food and energy – have also been on the rise the last three months, but only to a still low rate of 1.7 per cent. Therefore, one could wonder how effective the recent rate hikes are in damping inflation.

In any case, the real interest rates are still low or even negative, and a small increase from here is not likely to have any significant negative effect on the Chinese growth going forwards. Constraints on credit growth are probably a much bigger obstacle for the amounts of bank loans than the price (ie. the interest rate) is in it selves.

Yet, the announcement caused some negative immediate reactions yesterday, particularly in commodities, where the price of oil and cobber felt. The rate-hike also seemed to weight on European stocks, and not surprisingly, especially the heavily oil influent stock market here in Oslo.

But the initial market jiggery was over fairly quickly, and the trend was reversed - a pattern we also could observe in FX, where commodity sensitive currencies such as the Australian dollar came under pressure immediately, but regain strength during the afternoon. The Norwegian krone in a way followed the similar pattern, although it never managed to regain all what was lost versus the euro. EURNOK is currently traded around 7.86-7.87, versus 7.84 to 7.85 at the same time yesterday.

Elsewhere in FX, the euro has strengthened versus the US dollar. At the moment EURUSD is traded around 1.365, a touch higher than yesterday’s morning. The dollar weakening came despite the fact that the prices of US Treasuries eased for the seventh consecutive trading session (ie. the interest rates fell), and despite weaker-than-expected German production figures for December. A general improvement in the appetite for riskier currencies was probably to blame for the weaker USD. A broadly weaker Swiss Franc, which often is regarded as a so-called safe-haven currency, support this last explanation.

In the absence of any new and important macro releases today, the Fed Chairman Ben Bernanke’s testimony before the House Committee on the Budget will probably attract attention. Although the testimony is likely to steal headlines in the media, we highly doubt that Bernanke will give any new policy signals that will affect the markets. Instead, he is likely to give much of the same message as he did last week in Washington: The economic recovery shows signs of being more self-driven, but it is still not strong enough to bring unemployment down substantially.