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China Raises Rates For Fourth Time To Cool Inflation

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By Nipa Piboontanasawat

Aug. 21 (Bloomberg) -- China raised interest rates for the fourth time since March to cool the world's fastest-growing major economy after inflation surged to a 10-year high and the key stock index doubled.

The benchmark one-year lending rate will increase 0.18 percentage point to 7.02 percent tomorrow, the People's Bank of China said on its Web site. The one-year deposit rate will rise 0.27 percentage point to 3.6 percent.

China's consumer price index rose 5.6 percent in July, fanning concern that cash from record trade surpluses may cause the economy to overheat. The CSI 300 Index rose 25 percent in the past month, even as a global equities rout wiped at least $5.5 trillion from stock markets worldwide.

``This is a reflection of the central bank's concern about inflation and asset bubbles,'' said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong. ``We can't rule out another interest rate hike this year.''

It's the second time this year that deposit rates increased more than lending rates. The government is trying to make bank savings more attractive to stem the flow of money into property and stock speculation.

The increase is to control ``money supply and loans and stabilize inflation expectations,'' the central bank said.

`Bigger' Bubble

The government said yesterday it will let individual investors buy Hong Kong stocks for the first time, easing controls to let more cash flow out of the financial system.

Inflation has outstripped returns on bank savings. The government reduced a tax on interest income last week to 5 percent from 20 percent to make deposits more attractive.

``This is targeted at slowing the money flowing into the stock market,'' said Liao Qun, chief economist at Citic Ka Wah Bank in Hong Kong. ``As the bubble gets bigger, the chance of it bursting is also bigger.''

The CSI 300 closed 1.8 percent higher at a record today before the central bank's announcement. The index has climbed 144 percent this year after more than doubling in 2006.

Property prices have also surged. In July, housing prices jumped 19.4 percent from a year earlier in Shenzhen and 10.4 percent in Beijing.

Wang Qing, chief China economist at Morgan Stanley in Hong Kong, said the central bank may raise interest rates again in the fourth quarter.

Subprime Crisis

China's action contrasts with central banks in the U.S., Europe and Japan injecting money into their financial systems because of concern about the impact of the subprime mortgage crisis. The Federal Reserve unexpectedly cut its discount rate on Aug. 17 and dropped language indicating a bias toward fighting inflation.

Higher rates may add pressure for the yuan to appreciate. The currency fell 0.05 percent to 7.5906 against the dollar in Shanghai today, before the central bank's announcement.

A stronger yuan would help to curb the flow of money into the financial system and reduce tension with trading partners including the U.S. The currency has gained 9 percent versus the dollar since a revaluation in July 2005. U.S. manufacturers say the yuan is kept weak to make China's products cheap.

The central bank today proved ``that it is more hawkish than many observers believed,'' said Stephen Green, senior economist at Standard Chartered Bank Plc in Shanghai.

Besides raising rates, the People's Bank of China has ordered lenders to set aside larger reserves on six occasions this year. It has also sold bills to soak up cash.

Inflation Expectations

China's top priority is to prevent the economy from overheating and keep prices tamed, the central bank said in a quarterly monetary-policy report released Aug. 8.

Consumer-price increases aren't solely the result of ``temporary factors,'' the People's Bank of China said then, highlighting energy and labor costs and people's expectations for inflation.

Economists are split on whether the acceleration in consumer prices is short-term and limited to food or ``getting out of control,'' a term used last month by Tao Dong, chief Asia economist at Credit Suisse Group in Hong Kong.

Non-food inflation slowed to 0.9 percent in July from at least 1 percent in each of the previous five months.

``Today's move was all about inflation expectations,'' said Ben Simpfendorfer, a strategist at Royal Bank of Scotland Plc in Hong Kong. ``It has very little to do with the real economy.''

China's economy, the world's fourth largest, expanded 11.9 percent in the second quarter from a year earlier.

The trade surplus surged 67 percent in July from a year earlier to $24.4 billion, the second-highest monthly total. Money supply climbed 18.5 percent, the biggest increase in more than a year.

Fixed-asset investment in urban areas increased 26.6 percent in the first seven months from a year earlier, close to the 26.7 expansion in the first half.

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