China's interest rate hike on Wednesday could signal a period of slower, steadier growth for commodities prices, as the central bank tightens just enough — but not too much.
The rate hike by the People's Bank of China was both a vote of confidence in the economic recovery and an antidote to speculation, which is booming because inflation is higher than interest rates, encouraging people to park their savings in hard assets.
The biggest magnet for speculators is property, but excess cash has also poured into commodity futures and other assets, pushing up prices.
A pullback in property prices does not imply a fall in demand for construction-related metals such as steel, copper and aluminum, since the government also plans a massive building program to increase the availability of affordable housing.
"The cooling down of the property market is targeting prices and not volumes," said Graeme Train at Macquarie. "All the indications are that the supply side will be supported while the investment side will be restricted.
"We expect further policy measures on the property sector to cool prices to be supportive of commodity demand in the sense that they increase the volume of construction and bring more supply to the market."
Judy Zhu, commodities analyst at Standard Chartered Bank in Shanghai, said she expected a few more rounds of rate hikes before the property sector slows down and cuts into the fundamental demand for steel and other commodities.
"In light of real-estate tightening measures, China's steel demand for the fourth quarter will be more tepid compared to the first half," she said.
"But looking ahead into 2011, I think the downside risks to demand are going to be quite limited because overall demand is still strong and the economy is still going to grow at a healthy pace."
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Beyond property, the PBOC may have also hoped to skim some froth off agricultural and soft commodity futures, such as sugar, rubber, cotton and corn, where traditional pre-harvest tightness, bolstered by global supply setbacks, has spawned record prices.
Traditionally the government is especially keen to squelch any sharp food price rises, which can quickly cause wider inflation given food makes up one-third of the inflation basket.
"The interest hike is good for the commodity market," said Shi Chunsheng, deputy general manager of Zhejiang Yongan Futures Brokers Co. Ltd.
"Otherwise some futures prices would have lost all meaning, thanks to excessive liquidity and expectations of inflation. The hike may not have a big impact but at least it delivers a signal," he said. "If the government doesn't act to curb speculation, the market will go crazy."
Although the rate increase is expected to leave underlying growth intact, it may only remove the hottest money. Many Chinese commodity futures rose on Wednesday, apparently shrugging off the shock of the sudden, but small, rate increase.
"For years, the central bank used to raise rates by 0.75 percentage point. This time, it was only 0.25 percentage point, which reflected the fact that the government was carefully testing the market reaction to rate hikes," said Jing Chuan, chief researcher at Hua Tai Great Wall Futures in Shanghai.
The PBOC's apparent timidity may also have been caution, since raising by too much could attract more foreign investors, adding to pressure for the yuan to rise and increasing liquidity — exactly what the PBOC is trying to prevent.
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