Surprise China rate hike reveals country worried about inflation

chinese government flag

A China interest rate hike caught the world off-guard and shows the government is more worried about inflation than it is willing to admit. Image: CC peruisay/Flickr

The first China interest rate hike since 2007 caught analysts by surprise and knockedĀ  world markets off-kilter. The Chinese government offered no explanation, but consensus among experts is China has recognized the need to stem inflation in its economy. Fears that the China rate hike could drag on global recovery sent stock markets in Europe and the U.S. downward Tuesday, but some analysts think China will avoid any significant economic slowdown as it prepares for a 2012 leadership transition in the communist party.

The China interest rate hike

The China interest rate hike raises benchmark one-year lending and deposit rates by 0.25 percentage points. The New York Times reports that the China rate hike is proof that the Chinese government is struggling to control inflation, skyrocketing housing prices and an economy overly dependent on exports and excess investment. Many economists stress that China should raise the value of its currency, the renminbi, to fight inflation and increase imports. But the Chinese government fears that allowing the renminbi to rise will kill tens of millions of export jobs. Instead, it hopes the China rate hike will slow growth, get lending under control and encourage saving.

China’s overheating economy

A huge economic stimulus package and aggressive lending by state-run banks pushed China out of the global financial crisis in 2008. CNN reports that since then, the Chinese economy has expanded rapidly while western economies remain sluggish. China’s gross domestic product grew at a 10.3 percent annual rate in the second quarter. U.S. GDP rose 1.7 percent. China’s exploding GDP has lead to soaring wages, food prices and real estate values. Consumer prices in China rose 3.5 percent in August spurred by a 7.5 percent increase in food prices. Real estate prices rose 9.1 percent compared to a year ago in China’s largest cities.

Why China’s rate hike won’t work

Michael Pettis at Business Insider said that the China rate hike is too little to offset its inflation rate. China’s economy is so dependent on artificially low interest rates, the smallest increase will cause financial distress. Pettis writes that more China rate hikes in the near future may put a dent in the country’s over-reliance on excess investment. But with a communist leadership change looming in 2012, that is unlikely, no matter how badly China needs it.

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