With no major reports due on the U.S. economic calendar, China’s announcement today of further monetary tightening takes center stage. Notwithstanding the market’s positive momentum lately, today’s announcement will most likely prove a dampener. It would make sense for investors to cash out or stay on the sidelines today ahead of the long weekend and simmering tensions in the Middle East that keep threatening to boil over.
In an expected move, China’s central bank announced today an increase in banks’ reserve requirements. This is the second increase this year and the eighth since the beginning of 2010, aimed at reducing market liquidity and inflationary pressures. The latest hike takes the reserve-requirement ratio to 19.5%. The central bank has also been raising benchmark interest rates, having employed that tool once this year and twice last year.
Overall though, Chinese authorities have been slow in responding to the build-up of pricing pressures in their economy. They maintained an expansive policy stance even as the global economy started coming out of the downturn early last year. Chinese CPI was up 4.9% in January, following a 4.6% gain in December. Given recent trends, inflation will most likely remain above the official 4% target this year as well. The impact of unfavorable weather on certain key food crops adds to the trend.
China’s inability thus far to tackle its inflation problem remains a question mark for the global economic recovery. A more stringent policy response will most certainly address the problem. But the trick will be to resolve the inflation problem without negatively affecting the economy’s growth prospects. And that is not an easy balance to maintain.
Sheraz Mian
Director of Research
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