Central Bank raises benchmark interest rate twice despite inflation risk

BEIJING: China's central bank is poised to raise benchmark interest rates twice more in the first half of 2011 for a total tightening of 50 basis points, before keeping them steady for the remainder of the year, a Reuter’s poll on Wednesday showed.

Meanwhile, the People's Bank of China will probably increase banks' required reserves three more times this year to mop up more of the excess cash in the economy that is, in part, fanning price rises, according to a poll conducted a day after China raised interest rates.

The consensus of the poll of 24 economists based in China and abroad was that Beijing would stick to its gradual course of policy tightening, front-loading its moves before June, when inflation is likely to be most elevated.

China raised interest rates on Tuesday for the second time in just over six weeks, intensifying a battle in the fast-growing economy against stubborn high inflation.

Beijing is seeking to contain inflationary expectations as residents shift money from their bank accounts to investments from property to gold as a way to avoid negative real interest rates.

Although annual inflation slowed to 4.6 percent in December, analysts polled by Reuters expect it to have picked up to 5.3 percent in January, the fastest pace in more than two years, because of soaring food prices.

The median forecast was for the Chinese central bank to raise deposit rates by 50 basis points to 3.5 percent around the middle of 2011. The rate moves, likely done as two increases of 25 basis points each, were expected to come in the second quarter.

One-year lending rates were seen following deposit rates in lock-step. Currently 6.06 percent, they will rise to 6.56 percent by the middle of the year, the poll shows.

"Like other central banks in the region, the PBOC is looking to contain the pick-up in inflation. I think they can still take it gradually as there isn't any serious risk that inflation expectations are getting out of hand," said David Cohen, economist at Action Economics in Singapore.

At the start of December, analysts polled by Reuters said that benchmark deposit and lending rates would be increased to 3.25 percent and 6.31 percent, respectively, over the course of 2011.

The central bank has raised banks' reserve requirements several times since early last year, preferring to use this quantitative control as a way of limiting the amount of cash in the economy.

Worried that higher interest rates would attract speculative capital and cause undue harm to the economy, it has increased interest rates only three times.

"I think in the coming months, the central bank will use more reserve requirements rather than the interest rate tools to control inflation. It prefers quantitative tools," said E Yongjian, an analyst at Bank of Communications in Shanghai.

"That is to say, the central bank is unlikely to raise interest rates frequently or by much each time, as they must consider the risks of hot money inflows," E added.

The median forecast was for another three reserve requirement increases by the end of 2011, taking the official level to a record 20.5 percent for the country's biggest banks.

The analysts polled by Reuters at the start of December said that the reserve ratio would hit 20.0 percent this year.