China’s stocks and bonds drop amid rate concerns

China’s stocks fell yesterday, erasing earlier gains, on speculation the Chinese central bank will accelerate increases in interest rates after boosting borrowing costs over the weekend. Bonds dropped and yuan forwards climbed.

The benchmark Shanghai Composite Index declined 1.9 percent yesterday to 2,781.40 at the close, the lowest since Oct. 8. Commodity and consumer companies ranging from Aluminum Corp of China Ltd  to Kweichow Moutai Co slid more than 2 percent on concern that monetary tightening will slow economic growth.

Chinese currency forwards rose to a five-month high on prospects the government will allow further currency gains to contain consumer prices that reached a 28-month high last month.

“Investors were initially relieved as this interest-rate increase has been priced into stocks for a long time,” said Dai Ming, a fund manager at Shanghai Kingsun Investment Management & Consulting Co. “However, they’re now thinking about the future; that one increase won’t be enough to bring inflation under control and more rate hikes will be needed. That’ll keep depressing valuations of stocks.”

The People’s Bank of China increased key one-year lending and deposit rates by 25 basis points on Saturday in its second move since mid-October. The benchmark lending rate rose to 5.81 percent, compared with 7.47 percent before cuts from late 2008 to counter the global financial crisis. The deposit rate increased to 2.75 percent, compared with the 5.1 percent annual pace of inflation last month, the highest in 28 months.

Chinese Premier Wen Jiabao’s  government aims to limit asset bubbles in the real estate market and prevent rising prices from leading to social unrest after flooding the economy with cash from late 2008 to drive a recovery.

China’s monetary tightening next year might be mainly in the first half, JPMorgan Chase & Co and Morgan Stanley said. China may raise rates as many as three times in the first half of next year, according to Morgan Stanley, while JPMorgan forecasts two increases in that period.