The central bank's 27-basis-point rise for both deposit and lending rates from Saturday was unexpected, according to some economists.

The rise was unexpected because, compared to a month earlier, there had been less talk of an interest rate hike as the growth of both investment and the consumer price index slowed down in July. The market seems prepared for at least a few more weeks of wait-and-see before there's any real action on the rate rise.

But there's no doubt that an interest rate hike was just a matter of time the overall macro economy is still hot and has been expanding faster than expected, at 10.9 percent in the first two quarters. Some sectors are already overheating and lending growth remains strong despite efforts to rein it in.

"This (the latest rate hike) will not be the PBC's (People's Bank of China's) last step towards tightening liquidity to cool off investment overheating," said Qu Hongbin, Chief Economist China of HSBC. "We expect the PBC to take further tightening measures in the coming months, with a deposit reserve requirement hike, lending curbs and other quantitative measures being the most likely options."

This deposit rate increase will generate 40 billion yuan (US$5 billion) in extra interest income for households and should be slightly positive for consumer spending, Qu said.

But the rate hike is too small to have a meaningful impact on fixed-assets investment growth, which still remains very high at around 27 percent year-on-year in July, he said.

However, Liang Hong, China Economist for Goldman Sachs (Asia), is positive about the effect. A rising borrowing cost, Liang said, will be a much more effective tool to keep investment growth under control than previous tightening measures, including twice increasing reserve requirements for commercial banks since April and other macro-control measures.

China's market is very responsive to changes in interest rates, Liang said. And raising both lending and deposit rates is an improvement in policy adjustment compared with the April rate hike, which only applied to the lending rate.

She expected the central bank to further withdraw liquidities, raise the lending and deposit rates by another 27 basis points by year's end and appreciate the currency faster by widening the daily trading bands.

After the latest rate hike, the one-year benchmark renminbi deposit rate is now 2.52 percent and the one-year loan rate is 6.12 percent. But commercial banks are free to charge residential housing loan borrowers 15 percent below the benchmark rate or any higher rates at their discretion.

Liang said money and loan growth as well as activity growth should moderate in the coming months, but the tightening measures implemented so far should not lead to a sharp slowdown in growth.

A report by Standard & Poor's Ratings Services on Friday also said that the latest increase in China's interest rates reflected the government's continuing efforts to rein in rapid credit and investment growth.

Together with monetary and administrative measures previously implemented, economic expansion in the country is now likely to ease to more sustainable rates in the near future. And the government is likely to be successful in maintaining macroeconomic stability in the country, the report said.

However, with this increase and the pause in US monetary policy tightening, there is now less room for further moves upward for China's interest rate, though more policy curbs in the form of direct measures such as changes to reserve requirements or the introduction of more administrative measures are necessary.

The real estate industry will be the most affected by the interest rate hike, said Pan Xu, an analyst with Shihua Financial Information.

The immaturity of other financing channels such as trusts means China's real estate developers are still highly reliant on bank lending. Statistics indicate that around 70 percent of funds used for real estate development in China come from bank lending.

The higher borrowing rate will increase costs for real estate developers, Pan said. That, in addition to other credit curbs, will affect investment in the industry and divert some of the money to other markets with higher yields, such as gold.

The Agricultural Bank of China has already halted loans for the purchase of land reserves to comply with the banking regulator's efforts to clear up lending in the real estate sector, insiders said.

The dual control on land and credit is aimed at reducing costs in irregular lending and developing activities in the real estate industry, but some analysts said the central government may have to bring in even harsher and more comprehensive measures to cool down investment in the sector.

For homebuyers, however, higher housing loan rates do not raise costs too much, particularly with the flexibility of commercial banks in setting lending rates for buyers with good credit and first homebuyers within the permitted floating range.

This latest rise in the deposit rate puts China back in an interest rate hike cycle, which means the economy has entered an anti-inflation cycle, said Chen Xi, another analyst with Shihua Financial Information.

It is likely that concerns over inflation and more exposure to foreign exchange rates will drive more investors to the gold market.

(China Daily August 22, 2006)