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China raises interest rates, MPC divided.

China has announced its first rise in interest rates for three years. According to the People’s Bank of China, its one-year lending rate goes up from 5.31% to 5.6% and its one-year deposit rate also rises from 2.25% to 2.5%.

Why has China done this? In recent years double-digit rates of economic growth have become familiar in the country. In fact since January 2006 China has shown a mean growth rate of 10.27%. This is even though growth reached a trough of plus 6% in 2009 during a worldwide recession, a figure most of the western world has not recorded even in boom years.

China has raised interest rates amidst fears that the economy is overheating.

However, one bi-product of this is that inflation has been rising. In fact, it has gone up from -1.8% in July 2009 to 3.5% in August 2010, a turnaround of 5.3 percentage points in just over a year. There is also the matter of an overheating housing market in the most developed parts of the country, which the government does not want to escalate into a western-style housing bubble. There has also been a sizeable increase in bank lending recently which the Chinese government wishes to limit.

One downside of this move, is that higher interest rates may attract more overseas funds into the country which will boost the value of the currency, at a time when China is under fire, especially from the US, for having an overvalued currency.

The impact of this could be far-reaching. As Paul Krugman wrote in the New York Times yesterday: “So, the United States is pursuing an expansionary domestic monetary policy, which increases overall world demand; however, a side consequence of this is a weaker dollar. China is pursuing a weak-yuan policy; to counter the inflationary domestic effects of that policy, it’s pursuing a contractionary domestic monetary policy, reducing overall world demand.”

Meanwhile, back in the UK the details of last month’s Monetary Policy Committee meeting which left interest rates unchanged at 0.5%, show that the committee was split three ways. One member wanted to loosen monetary policy by extending the system of quantitative easing, which would pump more liquidity into the economy. On the other hand, another member voted to increase interest rates in order to bring down inflation levels. The other seven members voted to do nothing!

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Posted in China, economic growth, Interest rates, US economy

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