Excess liquidity also behind move, more increases expected this year

BEIJING - The central bank on Tuesday raised interest rates for the third time since mid-October by another 25 basis points, to help mop up liquidity and tame surging inflation.

Effective on Wednesday, the benchmark one-year lending rate will increase to 6.06 percent from 5.81 percent, and the one-year deposit rate will rise to 3 percent from 2.75 percent, the People's Bank of China (PBOC) said in an announcement on its website.

The tightening measure was announced right at the end of the Spring Festival holidays and one day before the markets open.

Lu Zhengwei, chief economist at Industrial Bank, said the move had been predicted as China maintains strong growth momentum, and the consumer price index (CPI), a major gauge of inflation, was expected to hit a record high in January.

The CPI rose 4.6 percent in December after jumping to a 28-month high of 5.1 percent in November.

The figure for January has yet to be disclosed.

The world's second-largest economy saw its growth expand by 9.8 percent in the fourth quarter of last year, compared to 9.6 percent in the third quarter.

"The risk of rising inflation cannot be neglected because major economies are expected to shore up their growth by maintaining an easy monetary stance. As a result, a large amount of capital flows into emerging economies," the PBOC said in a report published on Jan 30.

It added that rising costs for labor and resources also contribute to inflation.

Du Zhengzheng, a macro-economist at Bohai Securities, predicted that inflation will rise by 4 percent year-on-year in the first half of 2011, after surging to 5.2 percent in January.

"The pressure of increasing inflation has forced the PBOC to take action."

He said the central bank will not raise interest rates again during the first quarter, but may again hike the reserve requirement ratio for banks.

Dong Xian'an, chief economist at Industrial Securities, said there is still room to increase interest rates by 50 basis points throughout the year.

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China has been facing the challenge of excessive liquidity since late 2008, when the government initiated stimulus measures worth $586 billion and adopted a "moderately loose" monetary policy to propel an economy battered by the global financial crisis.

In 2010, new yuan loans reached 7.95 trillion yuan ($1.21 trillion), exceeding the government's target of 7.5 trillion yuan, while inflation jumped 3.3 percent year-on-year, exceeding the officially set ceiling of 3 percent.

In a December survey by the central bank, 74 percent of respondents said they were dissatisfied with rising inflation.

To combat inflation, China raised the reserve requirement ratio for banks six times and increased interest rates twice in 2010. The reserve ratio was again raised on Jan 14.

To curb inflation and control financial risks, the central bank announced earlier that it had set the growth rate target for M2, the broad measure of money supply that covers cash in circulation and all deposits, at 16 percent for 2011.

M2 rose by 19.7 percent in 2010 over the previous year, exceeding the officially set target of 17 percent, according to the central bank on Jan 11.

The PBOC also vowed to strengthen control over yuan lending, corporate debt and equity financing, to combat inflation.