More interest rate rises seen ahead on the mainland
Updated: 2011-05-06 06:19
(HK Edition)
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Rumor has it that the People's Bank of China (PBoC) will announce another interest rate hike in near term. In our view, it does not really matter whether the exact date falls in mid May or early June. What is more crucial is how long the trend will go on. Our recent research suggests that the current rate hike in China is likely to last for another three to five months amidst negative real interest rate as well as persistent inflationary pressure.
First, residential demand deposits remain high, implying certain inflationary pressure from the monetary side against a negative real interest rate. The ratio of demand deposits in household savings has been steadily climbing since May 2009, exceeding the previous peak of 38.4 percent in 2007 last September and hitting 40.9 percent in January 2011. While the ratio declined to 39.3 percent in February, it quickly rose back to 39.7 percent in March. In fact, the CPI movement resembles the demand deposit weighting trend as we found the correlation between the demand deposit weighting and the five month lag CPI reaches 0.76. Looking back, before the demand deposit trend reversed in December 2007, the one-year benchmark deposit rate had already been lifted to 4.14 percent. After two interest rate hikes in the first quarter this year, the one-year benchmark deposit rate is still only 3.25 percent. With the high inflation of 5.4 percent in March, it will be difficult to suppress residential settlement cash demand.
Moreover, the proportion of demand deposits has been dropping rapidly since December 2007, falling to the lowest point of 50 percent in April 2009. It rose back to 61.8 percent in January 2010 and stayed at above 60 percent for most months afterward. Due to the statistical adjustment, 2011 data is not comparable. After January's 45.5 percent, February came in slightly higher at 46.5 percent and March slightly lower at 46 percent. From the adjusted data, we see the demand deposit ratio is still higher than it was in 2007 and pre-crisis the first half of 2008.
Based on our analysis of the inflation situation and the demand deposit ratio, I believe single-month inflation will stay at around or slightly above 5 percent before leading up to the fourth quarter. While inflation may peak in July or August, it is not likely to see much of a fall before the National Day holiday and should remain high. I therefore reaffirm the prediction that benchmark interest rate hikes will keep the current two-month adjustment pace until August.
On the other hand, if September and October CPI see some significant decline and overall inflation of below 4 percent is expected for 2012, then the current inflation cycle should end after August. In this case, from October 2010 to August 2011, there would be a total of six interest rate hikes with the one-year deposit and lending rate up 150 basis points in total, reaching 3.75 percent and 6.81 percent, respectively. However, if month-on-month data for both September and October surpass expectations, another rate hike is possible in October 2011.
Besides inflation figures, open-market central bill issuance rates can be a useful indicator for the PBoC's interest rate hike. An upward adjustment of central bank bill rates usually foreshadowed a benchmark rate hike in the last inflation cycle starting in 2006. However, during the current inflation cycle, as the US Federal Reserve and the European Central Bank have kept interest rates low and as short-term government bond yields are much lower than the yuan central bill rates, the central bill issuance rates have been lagging behind the benchmark adjustments. The situation did not change until March this year when the ECB was about to increase key rates and large issuances were to reach maturity. The central bill rates started to lead the equivalent deposit rates of similar terms. Therefore, central bank bill issuance rates in the foreseeable future can be regarded as a leading indicator for benchmark interest rate hikes and people should keep an eye on it.
The author is executive director of BOCI Research Limited (www.bocigroup.com). The opinions expressed here are entirely his own and do not represent those of BOCI or any other affiliated companies within the group. Nothing in this article constitutes an investment recommendation.
(HK Edition 05/06/2011 page2)