Another Rate Hike From Chinese Central Bank?

Includes: FXI
by: Susan Weerts
The Chinese market is anxiously waiting for several key economic data to be released next week. Among them is the July CPI number on August 9. The July inflation number is expected to remain as high as June’s number, 6.4. The market increasingly speculates another rate hike could be announced by the Chinese Central Bank on or around August 10. If so, it will be the fourth consecutive rate hike in 2011 and likely the last one. The market will dissect the Central Bank’s action for a guideline on the rest of the year.
The inflation in June reached a three-year high, largely due to runaway food prices. The higher-than-expected inflation forced the Chinese Central Bank to break its tradition in July and announce a rate hike before the release of the June CPI number. The inflation in the second half year generally starts to taper down. Even though the pork price appeared to stabilize in July, the prices on other food items such as edible oils continue charging along.
The one-year deposit rate currently stands at 3.5%, far below the inflation. The negative real interest rate largely contributes to the Central Bank’s inability to mop up excess liquidity outside the banking system, which continuing to fuel the inflation and housing bubbles. Some analysts suggest a one-time big rate hike to close the gap, in fear that the small incremental rate hikes later on would destabilize the market. However, most analysts believe that a small last rate hike is more likely, given an already weakening economy.
July’s PMI dropped to 50.7%, near a breaking point between contraction and expansion. Its service index was also at its three-year low. Many mid- and small-size companies are struggling for survival. Tight monetary policy forces them to seek private lending as a last resort to stay afloat. The prevailing rates of these private lenders are generally somewhere between 5-10% monthly. The total amount of loan outstanding in the first half of 2011 was ¥7.76 trillion in China, private lending accounting for nearly half of it. Some private lending is said to be connected to various unscrupulous sources. Its practices often tread the line between legal and illegal, some outright criminal. No one knows how much of this private lending is actually a form of Ponzi scheme and what kind of financial risks it imposes on the system. The recent default of the private lending enterprises in Shihong City sheds some light on the risks involved.
The tightened monetary policy also takes its tolls on households. All the mortgage rates in China are floating. The 30-year mortgage rate is currently at 7.05%, a 10-year high. With a new rate hike, the interest payment on a ¥1,000,000 ($155,000) mortgage over a 30-year period would be doubled from a year ago. The increases on monthly payments further pinch family budgets that are already constrained by inflation. On the other hand, a widely-questioned government statistic showed that the average household income growth in all 31 provinces of China outpaced inflation in the first half of 2011, the increase of urban residents between 8.68-19.4% and rural residents between 12.8-31.7%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.