China Tightens Policy: What To Expect
This morning’s global equity market sell-off could have had something to do with the People’s Bank of China (PBOC)’s decision to raise the reserve requirement ratio from 15.5% to 16.0% for large domestic banks and from 13.5% to 14.0% for small banks from January 18. This followed two hikes in central bank bill rates, and is a clear sign that the government is beginning to worry that its huge monetary experiment will set off a surge in consumer price inflation. By the looks of the chart below, they seem right to be worried. Even though CPI came in at just 0.6% y-o-y in November 2009, history would suggest that prices are heading significantly higher.
China - Consumer Price Inflation & M1 Money Supply, % chg y-o-y
So with the PBOC moving to tighten policy, albeit from an extremely loose starting point, what will this mean for the economic recovery? In the best case scenario, expect to see asset price appreciation slow moderately, investment spending cool in the high order industries, and private consumption carry on accelerating regardless. In the worst case scenario, expect the property bubble to burst, the financial system to require another dose of government help, investment spending to seize up, and consumers to return into hiding. The Chinese decoupling story is about to face a tough test.