China raised its benchmark interest rate on Tuesday, a move that was widely expected, and European markets reacted by giving up some of their gains, a response that was also not unexpected.
Major markets in Europe were flat.
The People’s Bank of China said its benchmark one-year deposit rate would rise by a quarter percentage point, to 3%, and the one-year lending rate would increase by the same amount, to 6.06 percent. It was the second time in about a month that China’s central bank had raised rates in a bid to dampen high inflation.
Stock markets took a small knock on the news, a day after many of the world’s major indexes closed at their highest levels since the summer of 2008, before the collapse of Lehman Brothers set off the biggest bear market since World War II.
Other reports involving China, however, could be a factor in the commodities markets. The United Nations Food and Agriculture Organization warned that a severe drought was threatening the wheat crop in China, the world’s largest wheat producer.
The government-run news media in China warned that the country’s major agricultural regions were facing their worst drought in 60 years. World wheat prices are already surging. Though China has been essentially self-sufficient in grain, any move by Beijing to import large quantities of food in response to the drought could drive international prices higher, creating problems for less affluent countries that rely on imported food.
Wall Street markets were expected to be little changed at the open.
China’s rate increase came amid speculation that the European Central Bank and the Bank of England will lift borrowing costs earlier than many in the markets had earlier anticipated, as inflation has spiked above target levels.
Though the European Central Bank has had to contend with a debt crisis that has at different times threatened the existence of the euro currency itself, there are growing indications that rate-setters are getting nervous about consumer price inflation running at 2.4%, above the bank’s mandate of keeping it "close to but below" 2%.
Late Monday, Yves Mersch, Luxembourg’s top central banker and a member of the European bank’s rate-setting governing council, said interest rates might have to rise if the current energy-related spike in inflation is passed through to wage demands.
Volkswagen, for example, agreed to a wage deal Tuesday that ensures workers a larger share of soaring profits in the German auto industry, and that may signal an end to a decade in which pay barely kept pace with inflation.
Still, the effect of that deal should be muted. The VW contracts do not expire until next year, which means, for now, the deal is unlikely to add to the already worrisome inflation rate, or add to pressure on the European Central Bank to raise official interest rates.
Predictions of higher interest rates support the euro against the dollar at the moment because the Federal Reserve is not expected to alter its super-loose monetary policy any time soon, partly because it has a dual mandate of looking at employment levels as well as inflation.
The euro’s main pillar of support so far this year has rested on growing optimism that the European Union is getting a handle on the debt crisis that has already seen Greece and Ireland bailed out.
Some of that optimism was dented last week when a meeting of European leaders in Brussels failed to deliver anything concrete.
In Asia, China’s rate increase came after the markets had closed.
