China raised its interest rates last Saturday bumping the lending rate to 5.81% (compared to 7.47% before cuts in late 2008) and the deposit rate to 2.75%. This was the second time this year since it raised its rate initially in October. According to Morgan Stanley, China may raise rates as many as three times in the first half of 2011 while JP Morgan forecasts 2 increases for the same period.
China is boosting borrowing costs because it registered an annual inflation rate of 5.1% as of November while its fast economic growth faces overheating risks.
In 2011, the stock market will have its fair share of volatility triggered by variables such as the Chinese rates. Beware commodity investors as commodities are the first to be hit when rates are hiked. While it was nice of China to hike its rate on a Saturday in the middle of the holidays giving me the impression they wanted the news to go unnoticed and minimize market volatility, it won’t be the case in 2011. We all know this 1 increase won’t magically solve the inflation problem; more hikes will follow, along with the Chinese banks required to increase their reserve ratios in the coming months.
While Chinese interest rate hikes might hit stock valuations in 2011 by causing sell offs, try not to get caught with your margin maxed out. These drops might turn out to be excellent buying opportunities as hot money no longer welcome in China leaves to resettle in other markets such as the US which is doing all it can to encourage economic growth.
What a contrast to the USA’s Fed policy of pledging an extended period of low interest rates. I have to admit the Chinese have a nice problem on their hands: slowing down a fast growing economy. The IMF expects China’s economy to expand more than 9% in 2011 compared to US growth at 2.3% and European growth at 1.5%. In 2011 China’s economic growth might be slowing but its consumption of commodities will still be growing.