China Raises Interest Rates to Cool White-Hot Economy

China's central bank raised interest rates Thursday in the government's strongest move yet to cool an economy verging on overheating. The news sent resource stocks, oil and commodity prices lower around the world.

The People's Bank of China raised the minimum rate banks charge on one-year loans in local currency, the yuan, 27 basis points, to 5.85 percent. The increase, which goes into effect Friday, was the first since October 2004 when the central bank raised the lending rate the same amount.

Oil prices, which surged in recent months in part on growing demand from China, fell and shares of mining companies tumbled as traders bet that the growing demand for copper, steel and other commodities fueled by China's rapid expansion could slow.

The Chinese economy expanded at a 10.2 percent in the first quarter from a year ago, aided in part by hefty lending by banks. That raised inflation fears and that already debt-laden banks could end up saddled with more bad loans.

Much of the bank lending is pouring into factories, buildings and other fixed assets. While the central bank rate increase is a broad move intended to discourage lending in general, the government has also taken more targeted measures in sectors where growth appears to be outstripping demand.

The rate increase was not entirely unexpected as speculation that Chinese authorities would take steps to slow the economy by curbing lending or other steps had depressed Hong Kong's stock market over the last week or so.

The rate increase triggered a modest reaction in the currency market, with the dollar dropping as low as 114.22 yen.

But as traders concluded that the rate increase had little implication for China's currency policy, the dollar recovered to 114.85 yen.

"The market realized that the Chinese interest rate move doesn't immediately mean there are direct implications for the exchange rate regime," said Jeremy Stretch, currency strategist at Rabobank in London. "It's domestic economic fundamentals warranting a moderate tightening of monetary policy."

China is under international pressure, particularly from the U.S., to allow the yuan to strengthen at a more rapid pace than the government so far has allowed. U.S. manufacturers claim the yuan is undervalued, giving Chinese exporters an unfair advantage.

Chinese authorities have already imposed investment controls on the aluminum, ferrous alloy, coke and cement industries. The auto industry will be next, He Yanli, a vice director at the National Development and Reform Commission, a key economic agency, told Dow Jones Newswires on Thursday. He said the auto industry controls would be imposed soon.

China's car sales in the first three months this year rose 74 percent from the same period a year earlier to 890,000 units, the official Xinhua News Agency reported in early April, citing data from the China Association of Automobile Manufacturers.

The local auto industry began to pick up last year after slowing significantly since mid-2004 when the government took measures to curb bank lending to various sectors that it viewed as being in danger of overheating, including the auto industry.

Meanwhile, the government said it will shut small coke production facilities by the end of 2009 to help reduce overcapacity in that industry.

The move follows the setting of lower output capacity targets for the ferroalloy, cement and aluminum industries earlier this week.

Domestic prices for coking coal, used to make steel, have been falling as demand lags behind supply, causing losses.

Coke producers must close coking units with a height of less than 14 feet in eastern China by 2007 and in the west by 2009, the National Development and Reform Commission said in a statement posted on its Web site Thursday.