What is interesting is that the PBoC increased the minimum reserve requirement that banks must leave on deposit. This is used to control the money supply by restricting the bank lending multiplier - the more that a bank has to keep on reserve the less it can lend out and in theory, the less that it spent (thus slowing down an overheating economy). Such methods are little used in the West where reserve requirements have generally been decreasing. One reason is that banks usually find other ways of lending out money if the demand is there (Goodhart's Law).
The issue, is how credible are the PBoC policies? They seem to be making a drive to increase their credibility in the eyes of the world's financial markets by acting decisively and quickly.
The question is how many more rises will be needed and what will happen to growth? In theory an increase in the rate of interest will attract financial flows and push up the exchange rate...
See the FT article for details:
China raises interest rates
The People’s Bank of China raised lending and deposit rates by 0.27 percentage points at the weekend, the latest in a series of tightening measures by an increasingly activist central bank.
The PBoC said in an announcement late Saturday that the benchmark one-year lending rate would be increased to 6.39 per cent while the deposit rate would be set at 2.79 per cent.
The rate hike went into effect on Sunday and was the third increase in less than a year. The PBoC has also lifted the reserve requirement - the percentage of funds commercial banks must leave on deposit with the authorities - twice this year.
The decision to raise rates underlines the government’s concern about the country’s torrid economic growth, specifically excessive liquidity in the financial system and mild inflationary pressures.
The PBoC said in a statement that the move was necessary to balance growth, stabilise prices and improve the overall structure of the economy.
China’s leaders have suggested on many occasions that they are now focused on the quality, rather than just magnitude, of growth. Stimulating domestic consumption is another key goal.
Beijing uses a combination of monetary and administrative curbs to regulate its economy. In recent years, growth has mainly been driven by fixed-asset investment and exports.
Gross domestic product expanded 10.7 per cent last year, the highest rate in over a decade.
The weekend’s rate hike suggests policymakers are increasingly “willing to use market-based measures to manage the economy, and also able to tighten policy when the first signs of overheating begin to emerge, much earlier and more decisively than before,” said Hong Liang of Goldman Sachs, in a research note.
“This move will help further strengthen the central bank’s credibility, and help improve investors’ confidence in the duration of the cycle,” added Ms Liang.
Wen Jiabao, premier, said at his annual press conference on Friday that China’s economic development was becoming unsustainable. “Looking into the future, it is not a time for complacency,” Mr Wen said. “My mind is full of concerns”
The premier admitted credit issuance and investment had been excessive and noted China’s imbalance of trade and international payments. China’s trade surplus reached $23.8bn last month, the second highest monthly total on record.
Fixed-asset investment growth in cities has been slowing slightly this year compared to 2006, but money supply growth is at a six-month high and consumer inflation reached 2.7 per cent in February.
Many economists expected the latest rate rise and believe more could follow in the months ahead. The central bank raised rates in August and April of last year.