China Lifts Interest Rates, but Positive Long-Term Outlook for Base Metal Prices Remains

China’s Central Bank surprised on Tuesday with the first increase of interest rates in nearly three years. The rate hike indicates China’s Central Government confidence on its economy, excluding the possibility of an economic slump. Hence, SMM believes that outlook for base metal prices will remain favorable in the medium and long term.

Interest Rate Hikes Show Economic Recovery Pace Varies from Countries

Following India and Brazil, China became another one of the four Bric countries to raise the benchmark rates. Since mid 2009, Australia, Norway, India, and Brazil have lifted interest rates to cope with inflation pressures, while the US, EU, and Japan kept its loose monetary policy unchanged. Moreover, Japan took an easier monetary policy recently, and the US Federal Reserve is expected to introduce further quantitative easing policy on its November’s interest rate meeting. Those moves indicate that economic recovery in developed countries is evidently slower than that in new-emerging countries during the recovery process from the 2008 global financial crisis.

China Adjusts Monetary Policy Initiatively by Raising Interest Rates

China’s central bank raised the benchmark interest rate under the background of rapid RMB appreciation, largely indicating the accelerated inflows of hot money and heavy pressure from huge money supply, and it is not enough for China to curb inflation only through raising the reserve requirement ratio and open market operations. Meanwhile, China’s move to raise the interest rate is also considered as a response to the upcoming China’s inflation data due for release on October 21st. Since market players predict China’s consumer price index （CPI） in September will remain high, China’s Central Government has to lift interest rate to rein in consumer prices. At present, the pace of China’s economic recovery is solid, and China’s GDP in 3Q due for release on October 21st is expected to maintain the high growth, and there are no concerns of a double-dip economic recession left. In this context, China takes the initiative in cooling the economy before the breakout of negative impact from excessively loose monetary policies, a signal of China’s Central Government’s confidence in China’s economy.

Interest Rate Hike Curbs Base Metal Prices in Short Term

China’s interest rate hike has already exerted negative impact on equity and commodity markets overnight. The Dow Jones index ended 165.07 points lower to 10,978.62 points overnight, down by 1.48%, falling below 11,000 points for the first time since October 7th and the biggest intraday decline since August 11th, with the index weakening for the third day in recent four trading days. Standard & Poor’s 500 index finished 18.81 points lower to 1,165.90 points, down by 1.59%; the Nasdaq composite index fell 43.71 points to 2,436.95 points, down by1.76%; international gold spot price in New York slipped by USD 36.30 to USD 1,331.90/ounce, or down by 2.65%, setting a new low since October 7th and the largest intraday decline since early July; silver spot price finished 3.91% lower to USD 23.34/ounce, with intraday decline exceeding 4%. LME base metals moved lower across the board, and LME copper prices slipped below USD 8,200/mt for the first time since October 12th. As market expected an easier monetary policy by the US Federal Reserve, market was previously dominated by opinions of continuous depreciation of the US dollar as well as steady growth of commodity prices. However, market players began to sell off commodity currencies and commodities after the China’s central bank raised interest rates, but to hold the US dollar instead. Investors’ risk appetite has reduced due to expectation of tighter liquidity. Market concerned interest rate hike will depress speculative funds in base metals market, weighing on market sentiment.

Increased Interest Rates Won’t Change Long-Term Upward Trends in Base Metals Market

Given the unexpected interest rate hike from China’s central bank, base metals market is inevitable to be weighed down in the short run, and the global financial market will undergo volatile movements in recent days. In the medium and long run, however, the rate hike further confirms the fact that China is moving out from its economic bottom and capital liquidity in the market is ample. Under the context of the upcoming peak demand season of base metals and the expectation of US Federal Reserve’s looser monetary policy, brief price corrections will not change the established strong upward momentum in base metals market. It provides an opportunity for market players to establish strategic positions after market prices move lower based on market observations in recent two years.