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Increase in interest rates likely

China Daily, June 6, 2011

The People's Bank of China is likely to increase the interest rates banks must pay on deposits and the amount of money banks are required to hold in reserve to sop up the excess liquidity now found in the economy and slow inflation, said analysts.

The changes in monetary policy may happen before the National Bureau of Statistics makes an expected announcement this week saying that the consumer price index (CPI), an indicator of inflation, hit a record high in May, they said.

"The CPI's increase of 5.3 percent in April over where it had been a year before was obviously exorbitant," said Li Daokui, an adviser to the People's Bank of China and professor at Tsinghua University.

"The central government should and probably will curb this continuously rising inflation by raising interest rates. It would be reasonable to raise China's interest rates by at least 0.75 percentage points this year."

Lu Zhengwei, a senior economist with Industrial Bank, said he predicts the one-year benchmark interest rate for deposits may go from the current 3.25 percent to between 3.75 and 4 percent. After that, the government will raise the reserve requirement ratio for banks more frequently, he said.

An anonymous analyst with China International Capital Co Ltd said the rise in interest rates will occur in June, before the government's expected news about a large increase in the May CPI. The analyst predicted interest rates will go up one further time - probably in the third quarter.

"China's monetary policy in the short-term won't be loose," he said. "The People's Bank of China will continue to tighten it until at least the end of the third quarter, to check fast rises in inflation through adjusting interest rates and the reserve requirement ratio."

If interest rates are raised, that will be the third time that has happened this year. The two previous monetary measures put into effect in 2011 came roughly two months apart from each other. One was enacted on February 8, the last day of China's Spring Festival holidays, and the other on April 5, the last day of the Qingming (Tomb-sweeping) holiday.

A glance at the calendar raises worries that a similar decision will be made on Monday, the last day of the Duanwu (Dragon Boat) Festival holiday.

Li Huiyong, chief macro-economy analyst with Shenyin & Wanguo Securities, predicted that China's May CPI may jump by 5.2 percent above what it was last year, and in June and July will rise to between 5.6 percent and 5.7 percent above what it was during those months in 2010. "The increase to more than 5 percent may last until October."

Credit Agricole Corporate and Investment Bank agreed in a research note saying the CPI will peak at around 6 percent this year, making it impossible to reach the government's target of a 4 percent average increase for the entire year.

"The rises in interest rates have been difficult to impose fast enough to keep up with the CPI's pace, making increases in interest rates an indispensable means of limiting inflation," said Li.

Not all agree.

Lian Ping, chief economist for the Bank of Communications, believes a rate increase may very well come before the end of the month but said there is also a chance that the increases in interest rates will come to an end soon, according to a Xinhua News Agency report on Sunday.

Lian said that stagflation, a combination of high inflation and an economic slowdown, is unlikely to occur in China. Inflation, he explained, will probably fall in the second half of the year, reducing the need for even higher interest rates.

Although he agreed the CPI will rise in May by 5.5 percent above what it was a year before and climb even higher in June and July, he said weak consumption and an economic slowdown will drag down the CPI figure over the coming months. He also said the continued appreciation of the yuan will cause a fall in the relative price of imported commodities and thus help to curb inflation.