China Stocks, Bonds May Drop Little as Rate Increase Follows Cash Squeeze

December 27, 2010

By Hanny Wan, Bloomberg News

China’s second interest-rate increase since mid-October may have limited impact on stocks and bonds because the central bank’s stricter controls on lending have already roiled markets.

“I don’t see a big slump in the market, because the recent decline has more or less priced in the rate increase,” said Zhao Zifeng, who helps oversee about $10 billion at China International Fund Management Co. “Large-capitalization stocks are already close to historical lows in terms of valuations.”

The central bank said on Dec. 25 it would raise its benchmark one-year lending rate by 25 basis points to 5.81 percent, and the one-year deposit rate the same amount to 2.75 percent. Theseven-day repurchase rate, which measures lending costs between banks, has more than doubled in the past two weeks and reached a three-year high of 5.67 percent on Dec. 23.

The cash crunch contributed to a 13 percent decline in the Shanghai Composite Index of stocks this year, the biggest drop among the world’s 15 largest equity markets, including a 2 percent loss last week. The yield on the benchmark 10-year bond climbed 50 basis points, or 0.5 percentage point, this quarter to 3.83 percent, according to the China Interbank Bond Market.

Chinese Premier Wen Jiabao is seeking to slow gains in property values and consumer prices that are making it harder for families to buy homes and pay for food. China reported 5.1 percentinflation for November, the highest in 28 months. There were rumors about a 50 basis point increase so “some may even take this as a positive,” Ting Lu, an economist at Bank of America Corp.’s Merrill Lynch unit, wrote in a Dec. 25 note.

Quantitive Measures

The rate increase “is more a signaling tool than anything else,’’ Yu Song and Helen Qiao, analysts at Goldman Sachs Group Inc., wrote in a Dec. 25 report. “We still expect the government to take a combination of measures to control inflation, including further rate hikes and possibly slightly faster currency appreciation, and believe the heavy lifting of controlling inflation will still fall on quantitative measures.”

The People’s Bank of China raised rates for the first time since 2007 in October, and ordered lenders to set aside more money as reserves for the third time in five weeks Dec. 10. Chinese new bank loans have fallen for two straight months, to 564 billion yuan ($85 billion) at the end of November from 596 billion yuan in September, government figures show.

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