October 20,2010

PBoC Rate Hike: Well Received in a Bull Market

By Hong Hao,Beijing

Mild inflation, surging property price in many major cities and strong investment growth ?sounds familiar? But we are not talking about the situation we are coping with right now. Rather, it was the reality in 2006, when the PBoC subsequently started its last tightening campaign, and persevered until the first half of 2008.


Typically, the PBoC tightens when inflationary pressure is starting to build, significant resource bottleneck exists, or/and when asset prices turn bubbly. There have been three other tightening cycles since the 1980's. The 1988-89 and 1993-96 episodes when inflation hit ~28% are not comparable. The 2004 episode saw a severe capacity constraint in the transportation and power generation sectors, which is largely absent in the current cycle. As such, the current situation bears more resemblance to that of early 2006, the initiation of a strong bull market.


Given these observations, the PBoC's 25bps rate hike yesterday after the market should not have come as a surprise. After all, inflation in recent months, especially food prices, has been rising. And despite the regulatory efforts to rein in property speculation, property price in many of the major cities are still registering strong gains. That said, given the relatively short supply cycle in many food products and the large output gap, inflation is likely to peak out in the coming month. As such, this rate hike is more of a preemptive strike on property speculation.


Indeed, rate hikes tend to be well received in a bull market, although RRR hikes less so. Further, banks' interest margins are largely protected, as much deposit in the banking system has maturity shorter than one year. Developer financing is not likely to be affected, as loan availability is restricted more by regulation than by interest rates. As real interest rate is still negative, it pays to take on risk in the market.


(Hong Hao is a Global Strategist Equity Market of CICC.)


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