China’s surprising rate hike is not cooling metal markets in medium-term

The People’s Bank of China, the central bank, surprised markets last Wednesday with the first rate hike since 2007. It lifted interest rates for deposits and credits by 25bp each. The one-year benchmark loan rate is now at 5.61%. While the metal markets came under stronger selling pressure on October 19, the industrial metals recovered again. Only gold and silver remained under pressure and reversed their upward trend. However, these two precious metals already showed signs that a consolidation might be looming before the announcement of the PBoC.

We expect that the medium-term impacts of the rate hike by the Chinese central bank on precious and industrial metals will be rather small. It is not sufficient to derail the strong growth of the Chinese economy and it will also not prevent the US dollar to weaken further against the major currencies.

The timing of the rate hike has surprised many traders, investors and analysts. This could be seen as another indication that markets are not information efficient as the academic theory pretends. Unlike the hard-drive of a computer, the human brain stores information, but it also automatically removes information to get fresh storage capacity for new information. The computer only sends a disk full message in this case. A glance at the calendar would have been sufficient to expect a measure announced by China to take off some pressure ahead of the G20 summit, which took place at Friday, October 22 in South Korea.

And the old trick worked again. China was praised for the rate hike and the US was blamed for its monetary policy. It is said the thinnest book is the one about German humor, but the country seems to have the most fools and the biggest one appears to be the Minister of economics, Mr. Bruederle (see also article below). The most foolish comments came out of Germany over the weekend.

In its statement on the rate hike, the PBoC does not cite any reason for the move. However, most commentators refer to the increase of the consumer price inflation. In September, the CPI rose 3.6% from the same month one year ago. At a first glance, this might justify a rate hike to keep inflationary pressures under control. However, at a closer inspection, the move by the PBoC was not the most appropriate measure. Inflation in China was driven by surging food prices. The rally in agricultural commodity prices was not caused by expansionary monetary policy, neither in China or other economies. Large speculators held even huge short positions in grains at the beginning of the summer season in the Northern Hemisphere. The drought in many regions, especially in Russia and the Black Sea area, caused a short-fall of grain harvests compared with forecasts. Russia even had to impose an export ban on wheat. Smart central bankers know that they can not fight the weather by interest rate policy. But most German commentators and central bankers prefer to curb domestic demand by tighter monetary policy if rising food prices are the cause of increasing headline inflation rates.

The imbalances of the Chinese economy are well-known. China’s private consumption is too low, its savings rate too high. The rather high contributions to GDP growth by the trade surplus and investments are reflecting the excessive savings rate. Increasing interest rates not only for credits but also for deposits is the wrong measure. It increases the incentives to save even more, which could lead to a further decline of the relationship of private consumption to GDP in China. Instead of reducing the imbalances, the problem could be even aggravated. Again, it is rather foolish to praise the rate hike as the right measure to reduce the imbalance of the Chinese economy.

China’s political leaders resist appreciating the yuan more strongly against the US Dollar. However, this would be an appropriate measure. A stronger yuan would reduce the impact of higher international food prices on the consumer price index in China. It would also help to reduce the imbalance between private consumption and export driven growth. And a 25bp rate hike is likely not sufficient to reduce GDP growth to the extent that falling prices of other goods compensate the impact of rising food prices on CPI inflation. Therefore, also the demand for base metals is likely to expand further in 2011, maybe at a slightly slower pace, but still sufficient strongly that a supply shortage of copper will prevail as the ICSG forecasts. Only a series of stronger rate hikes might have a negative impact on Chinese demand for industrial metals.