Diminishing Impact of Chinese Rate Hikes

For the second time this year and the fourth time since 2010, the Chinese government raised interest rates by 25bp, bringing its lending and deposit rates to 6.31 and 3.25 percent. Like many other countries around the world, China is worried about rising inflation pressures and the negative impact that it could have on inflation expectations and the overall economy. Over the past year, China has tried to combine rate hikes with higher reserve requirements for banks and the results have been limited. The recovery in the global economy has boosted growth expectations for China, forcing the central bank to take continued actions to slow their economy. While the timing of the announcement was a surprise, everyone expected more tightening from China because of the strength in commodity prices. In addition, China rarely make one-off moves which explains why the market’s reaction to China’s rate hike was so muted. High yielding currencies initially sold off after China’s announcement but since then, they have recuperated nearly all of their losses.

Diminishing Impact of Chinese Rate hikes

Each Chinese rate hike has had a smaller and smaller impact on the currency market. The first rate hike back in October elicited the biggest reaction because it was the first rate hike in nearly 3 years. At the time, all of the pro-cyclical currencies plunged against the U.S. dollar with the euro falling 1.5 percent and the Australian dollar declining by more than 2 percent. When China raised rates again on Dec 27th, the euro ended the day slightly higher against the U.S. dollar while the Australian dollar remained unchanged. In February, the reaction was slightly larger in the EUR/USD, GBP/USD and USD/JPY but the AUD/USD and NZD/USD ended the day higher. The price action today is even more muted as indicated in the chart below which suggests that investors are skeptical about China’s ability to tame their roaring economy. Slower Chinese growth is undoubtedly negative for global growth but we have been down this road before and even though there have been signs of slower growth in the Chinese economy, it has not had a significant impact on demand.

Rising inflationary pressures is the primary motivation behind China’s rate hike. With commodity prices continuing to rise, China did not want to take any risks, opting to preempt a further increase in inflationary pressures by raising interest rates. Given the health of the Chinese economy and the prospect of stronger global growth, we have not seen the last of China’s policy actions. We expect more interest rates hikes and more reserve requirement ratio hikes in 2011.

*April reaction is based on currency value change from Chinese rate hike announcement to 9am NY Time / 13:00 GMT

About Kathy Lien 236 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of DailyFX.com, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Investopedia.com Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for Tradingmarkets.com, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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