China’s benchmark deposit rates shoots to 6.56%

The one-year benchmark deposit and lending rates have been raised to 3.5 and 6.56 percent, respectively.

This move - slightly later than expected -suggests that the tightening stance of PBoC has remained unchanged. It counters the conjecture in recent days that the perceived tightness of domestic liquidity conditions, combined with concerns about the public debt burden, will deter PBoC from hiking rates. The interest hike also pre-empts the release of June inflation data next week - inflation is estimated to have exceeded 6% yoy, the highest reading in three years. High frequency data suggests that food prices, particularly those of pork, surged in June. Indeed, while the year-on-year inflation reading may improve somewhat in the latter half of the year largely due to base effects, sequential inflationary pressures are likely to persist as in recent months.

We maintain our forecast of two more interest hikes in the remainder of the year, which should help to anchor inflation expectations and push up the cost of capital. The persistent price pressures also suggest that credit and liquidity controls may be tightened. In addition, reducing fiscal stimulus including by delaying new infrastructure projects increasingly looks like a possible part of the policy package to rein in domestic demand.