China's Rate Move Hits Markets

By ALEX FRANGOS

HONG KONG—China's surprise interest-rate increase prompted a global market pullback, underlining China's influence on markets even as some interpreted the move as a sign that the world's second-largest economy is on firm economic footing.
Currency markets reacted swiftly, with countries that depend on Chinese demand for their commodities seeing the biggest impact. The U.S. dollar rose 1.8% against the Canadian dollar and 2.4% against the South African rand. The Australian dollar, seen as the closest proxy for China's economy, fell 1.8% against the greenback in midday trading. The euro was also weaker Tuesday morning.
The Dow Jones Industrial Average fell more than 100 points to 11036 in morning trading. Commodity prices, especially for oil and gold, were lower too.

The People's Bank of China announced late Tuesday that it would raise its benchmark policy rates by a quarter of a percentage point, the first such move since December 2007. China has already tightened policy in other ways this year, raising reserve requirements for banks and targeting reduced lending for real estate.
The increase signaled that Chinese officials are worried about inflation and that the property sector hasn't slowed in the face of tightened lending. While preventing too much inflation is generally considered a good thing among investors, some fear that the government could go too far and snuff out growth.

Chinese and other Asian stock markets were closed when the news broke. Trading on Wednesday could bring a retreat from what has been an impressive run in recent weeks. Shanghai's Composite Index rose 1.6% Tuesday before the announcement, breaching the 3,000 level for the first time since April. It has risen more than 15% in the past three weeks.
Property stocks, in particular, could take the brunt of the rate-increase news when markets in China open. "As long-term bond yields will also rise as a result of the deposit rate hikes, the increased attraction of bonds will also help limit property speculation," said Jun Ma, China economist for Deutsche Bank in Hong Kong.

Some believe China's tightening is a welcome sign. "Generally we see this as a broadly positive development, that policy makers are more confident of the economic trends," says Manik Narain, emerging markets strategist at UBS in London. "All in all, this is China coming from a position of strength."
Khiem Do, a fund manager for Baring Asset Management in Hong Kong, figured the market is due for a "healthy" correction given the recent run. But he says any slide will be short-lived. "Valuations are not expensive, growth in Asia is still solid, [and] investors are not yet fully invested," Mr. Do said.

Investors in China's stock markets place particular weight on government lending policy, often selling some holdings when tightening moves are made. Mr. Narain of UBS warned that a drop in China's stocks Wednesday could spread to other markets that have come to look to China as a leading indicator.
The move on interest rates comes at a sensitive time in currency markets. Brazil announced additional measures Monday to slow inflows into its markets. And South Korea's finance minister said Tuesday that the government was considering reinstating a withholding tax on foreign investors' holdings in some Korean securities.
Some markets interpreted China's move to raise interest rates as a sign that the country could move away from what has been a slow but steady appreciation of its currency against the dollar in recent weeks. Pricing on derivatives known as nondeliverable forwards indicated that investors believe the yuan will appreciate 3% versus the dollar over the next 12 months. A day ago, investors were betting on a nearly 4% appreciation. The thinking is that by raising rates, China will have less need to let its currency rise. A rising currency, like higher interest rates, serves as a brake on inflation.
But analysts cautioned that China is just as likely to both raise rates and allow its currency to strengthen in the face of faster-than-desired inflation.
"They are worried about strong growth and inflation, and so we look for a combination" of interest-rate increases and yuan strength, said Win Thin, currency analyst for Brown Brothers Harriman in a note. He suggested investors use the dip in markets to increase bets that the yuan will continue to appreciate. (Fonte: Wall Street Journal)