China interest rates

In the last months, the Bank of China has surprised investors globally by raising interest rates. On October 20^th, it raised key rates for the first time since it cut rates in December 2008.

Since then, the Bank of China has raised the rates a second time, announced on December 22^nd increasing its benchmark deposit rate to 2.75% and the one-year lending rate to 5.81%.

Why?

The main reason for this sudden increase in rates was to keep inflation under control, which has shown an increase over the last 8 months. The consumer price index rose 5.1% in November, reflecting this inflation.

China’s economy has been rising steadily at an average rate of 10% even with the current recession, which in turn also fuelled the economic engine and drove prices up.

This increase in interest rates indicated that China is determined to fight against stubborn inflation, soaring house prices and a floating economy that is pumping out exports and accumulating huge amounts of foreign exchange reserves.

What effect does it have?

China’s raise in interest rates took many investors by surprise and has had a big effect on global economies.

First of all, the change in these rates caused many investors to assume that China could slow and crimp global economy. This meant that many investors lowered their expectations on the second largest economy and removed bets on raising economies like China itself. This pushed the dollar up since money flowed back to the USA.

However, a decrease in other currencies could be seen as the Euro, the Australian dollar and others went down. The Chinese Yuan decreased in value.

Another effect of this change in interest rate is on the stock market. Now, as interest rates rose, the Chinese banks presented a new method for saving money that had before not been so attractive. The new alternative to saving money affected stocks as the Chinese demand decreased. the Dow Jones Industrial Average lost 1.5% to close at 10978.62 after the first increase in the rates

Chinese demand plays a great role in setting commodities prices. The prices of commodities, therefore, went down. Oil prices suffered their biggest decline in eight months, losing more than 4% to $70.49. Gold fell 2.63% to $1335.10 after having set a record high the week before.

Exchange rates

An exchange rate is the price at which one currency can be traded for another.

Exchange rates are determined by the supply and demand of one currency. In this case, factors affecting the demand are the interest rates in different countries, future views on a currency and the trade situation of a country (is it mostly importing or exporting?)

A strong currency, for example, is good for importers as it will make selling products in that country cheaper. For the exporter, it is bad as it makes products more expensive abroad, resulting in fewer sales.

The value of a currency is determined by those who buy and sell a currency. This could be companies aiming to make the highest profits, governments to maintain the currency at a certain level or foreign tourists like you and me.

The foreign-exchange markets (Forex) attract trillions of dollars every year as speculators try to guess trends in currency movements. However, this market is considered the most unpredictable and changing market of all.