WRAPUP 3-China surprises with first rate rise since 2007

* China’s rate rise is first since Dec. 2007

* Global investor sentiment dented by surprise move

* Analysts says rate rise could be start of tightening
cycle

* Speculation move is part of pre-G20 deal with U.S.

By Aileen Wang and Tom Miles

BEIJING, Oct 19 (BestGrowthStock) – China’s central bank surprised
on Tuesday with its first increase of interest rates in nearly
three years, a move that reflects concern about resurgent asset
prices and could mark the start of a more aggressive phase of
monetary tightening in the world’s fastest-growing major
economy.

The People’s Bank of China said it was raising benchmark
rates by 25 basis points, taking one-year deposit rates to 2.5
percent and one-year lending rates to 5.56 percent.

If there was ever any doubt about China’s role in driving
the stuttering global economic recovery, the impact was felt by
markets across the board. Oil and gold prices tumbled, stocks
turned negative in Europe and the dollar jumped.
[ID:nN19125123] [ID:nLDE69I1CS]

“The interest rate rise is entirely outside of market
expectations,” said Zhu Jiangfang, chief economist at CITIC
Securities in Beijing.

“The recent rise in headline inflation has put the real
rate into negative territory. And I think that’s why the
central bank needs to raise interest rates in such a hasty
way,” he said.

Some analysts said the rate increase also suggested a deal
was in place between China and the United States to strengthen
the yuan and put an end to worries about a currency war of
competitive devaluations ahead of upcoming Group of 20
meetings.

But others said just the opposite was the case — with
higher rates, Beijing can afford to rely less on currency
appreciation to keep the economy on an even keel.

Finance ministers of the G20 major economies will aim to
tackle the currency strains in a meeting in South Korea
starting on Friday. The country also hosts a G20 leaders’
summit in November.
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Graphic on China lending rate http://r.reuters.com/fyj29p

Rate rise to hit stocks, yuan rise may slow [ID:nTOE69I09D]

Preview of China data due this week [ID:nTOE69D042]

Related stories on China rate rise [ID:nLDE69308R]

China raises big banks’ required reserves [ID:nTOE69A03Y]
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Although announced by the People’s Bank of China, the
decision to increase rates would have received approval from
the highest echelons of Chinese power, with Premier Wen Jiabao
likely signing off on it.

Once a consensus has been forged in Beijing to raise or cut
rates, past experience shows that moves often come in bunches.

In the view of some, it is about time for China to embark
on a more aggressive tightening cycle. To date, it has relied
on lending restrictions and banks’ reserve requirements to keep
growth from boiling over.

“Fundamentally, policy rates are just too low for an
economy that’s growing around 10 percent. To avoid bigger
distortions, China needs to start moving rates to more
appropriate levels,” said Rob Subbaraman, an economist with
Nomura in Hong Kong.

“China’s economy (Read more about the fastest growing economy.) looks as though it’s decoupling from other
major economies, and its policies should as well,” he said.

DEBATED BUT UNEXPECTED

A number of leading economists, including some advisers to
the central bank, have urged an increase in deposit rates to
keep savers’ returns in positive territory.

China reported consumer inflation of 3.5 percent in the
year to August and economists expect that the pace climbed to
3.6 percent in September.

Still, the increase in rates is surprising given that
several top leaders have recently expressed confidence that
inflation is under control, and have said that higher rates
would potentially suck in speculative capital from abroad.

“They did it now likely because Thursday’s GDP and CPI data
is too strong for them,” said Dariusz Kowalczyk, senior
economist at Credit Agricole CIB in Hong Kong.

China is due to report third-quarter GDP and a suite of
economic data for September on Thursday. The consensus forecast
is that economic growth slowed to 9.5 percent year-on-year last
quarter, down from 10.3 percent in the second quarter.

Economists polled by Reuters last month had expected an
extended period of interest rate stability in China, with no
increase until the second quarter of 2011.

COLD WATER ON MARKET?

Propelled in part by these expectations of low rates,
Chinese asset prices have shown signs of taking off.

The Shanghai stock index (.SSEC: ), a laggard for much of
this year, has jumped nearly 16 percent in the past nine
trading days. And despite a months-long campaign to clamp down
on the real estate market, housing inflation has started to
perk up again.

“This is a bucket of cold water for the market,” said Zhang
Yuheng, an analyst with Capital Securities in Shanghai. “The
hike itself is not a big one, but the psychological impact is
big as the expectations for more rate hikes will appear.”

Higher rates make yuan-denominated assets more attractive
and could in theory place upward pressure on the Chinese
currency. Until a fall on Monday, the closely managed currency
had risen 2.5 percent against the dollar since the end of
August, its quickest pace of appreciation since a 2005
revaluation.

“It certainly leads to speculation that the U.S. and China
are in some sort of a deal which will perhaps see the U.S.
taking a more gradualist approach to QE (quantitative easing),”
said Simon Derrick, head of forex research at Bank of New York
Mellon.

The speculation was also fuelled by recent events. U.S.
Treasury Secretary Timothy Geithner said he had delayed a
report due last Friday into whether Beijing manipulates the
yuan’s value to win time to drum up support within the G20 for
“improvements” in the currency policies of China and other
emerging economies.

On Monday, he said the United States would not devalue the
dollar to gain an export advantage. [ID:nN18291636]

Beijing, and other emerging markets, complain that loose
money in the United States is generating an influx of
speculative capital and weakening the dollar, while Washington
and others say a deliberately undervalued yuan gives China an
unfair trade advantage.

But Ting Lu, an economist with Bank of America-Merrill
Lynch in Hong Kong, said the exchange rate’s rise would be
capped.

“The People’s Bank of China will firmly control the pace of
yuan appreciation once pressure from U.S. politicians is
alleviated,” he said.
(Additional reporting by Reuters bureaux around the world;
Writing by Simon Rabinovitch: Editing by Neil Fullick)

WRAPUP 3-China surprises with first rate rise since 2007