Money

Economic uncertainties check stock market rally

By Li Xiang (China Daily)
Updated: 2010-10-25 10:58

A vendor arranges vegetables at a market in Beijing. Some economists expect even higher inflation for China in the next two years. [Photo/Agencies]?

Fears of inflation prompt analysts to predict new wave of rate rises

BEIJING - The strength of the liquidity-driven rally in the Chinese stock market may be weakened in the coming months as uncertainties still remain in the Chinese economy which has shown signs of moderate slowdown, analysts said.

"The rally in the equities market was a result of the liquidity wave caused by the latest round of quantitative-easing policy adopted by central banks around the world," said Tu Jun, an analyst at Shanghai Securities. "But the excess liquidity is not necessarily a sign of solid economic growth."

The devaluation of the US dollar and the United States Federal Reserve's loose monetary policy has driven massive and potentially destabilizing flows of capital into emerging countries, including China, which has helped push up assets and commodity prices.

The liquidity wave has also lifted the A-share market, which has rebounded by 25 percent from July's low level. Tu said that the rally may be coming to an end as a new round of interest rate hikes may begin in China.

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China's central bank raised the benchmark interest rate by 25 basis points, which analysts said may mark the onset of a tightening cycle.

Tu said that the Shanghai gauge can hardly surpass the level of 3,400 points given the fact that the rally was largely driven by excess liquidity rather than the improving performance of the listed companies.

In the meantime, some economists said that China still faces strong inflationary pressure after the country's consumer prices accelerated by 3.6 percent in September, the highest in 23 months.

The International Monetary Fund warned in a recent statement that strong capital inflows combined with easy monetary policy conditions may pose risks to financial stability in emerging economies and further policy tightening may be needed.

Some economists expect even higher inflation for China in the next two years and more rate increases may be coming after the central bank raised borrowing costs on Oct 19 for the first time since 2007 to avert asset bubbles.

"We expect higher inflation in 2011 and 2012, driven not only by rising food prices but also by accelerating non-food factors, including higher costs of labor, land and other inputs, which we think will become increasingly difficult for China's productivity growth to match," Robert Subbaraman, chief economist for Asia excluding Japan at Nomura International Ltd, wrote in a report.

"The risk is inflation will remain an issue and that's why next year we have four more rate hikes as our forecast," Subbaraman was quoted by Bloomberg as saying. He predicted a one-percentage point increase in the interest rate by the Chinese central bank in 2011.