Pressure builds for China rate cut The People's Bank of China is tipped to act after twice raising rates last year. Picture by AP Source: The Australian THE prospect of an interest rate cut in China is growing after a sudden surge in the nation's short-term money market rates. The Shanghai Interbank Offer Rate (Shibor) has spiked in the past week to the highest level in more than a year, prompting fears of a liquidity crisis in China's financial system. The rate, which measures the rate at which banks lend to one another, has surged as the demand for money in China over the past week has risen dramatically. The repo rate, which is set by the People's Bank of China, has risen to nearly 10 per cent, well up from its average of 3 per cent. The seven-day interbank rate rose from 5.14 per cent to as high as 6.66 per cent while the overnight rate hit 8.3 per cent, up from 5.98 per cent. The spike in short-term rates could be the result of China's commercial banks hoarding cash before a three-day holiday last week. However, economists believe the increase could reveal that China's financial system is showing signs of stress, which could lead to the PBoC cutting the official interest rate. Most economists predict a rate cut will occur in the second half of the year. It would be the first this year after the central bank cut rates in two consecutive months last year. ANZ chief economist Liu Li-Gang said the PBoC should not underestimate the falling confidence that companies and citizens had in China's financial system. "An interest rate cut is imminent," Mr Liu said. As the risk of inflation diminishes and economic activity is sluggish, China's monetary policy stance should turn to be more supportive of growth. Central banks in the region have cut interest rates and used intervention to ease the pressures of currency appreciation and export competitiveness. The trade balance in China fell sharply last month after exports grew by just 1 per cent. The current lending rate in China is 6 per cent, compared with the deposit rate of just 3 per cent. China's central bank, the PBoC, ordered two interest rate cuts last year, in June and July, to stoke the economy. The government is aiming for the economy to grow by at least 7.5 per cent this year. A number of economists have started to cut their growth predictions this year, after the first-quarter numbers this year were weaker than expected. "We believe it's going to be difficult for the PBoC to maintain a relatively high policy rate and allow the renminbi to appreciate in the short run," Mr Liu said. A strong currency, sluggish real economic activity and limited inflation have set the conditions for the PBoC to cut rates. Mr Liu said he believed the rate cut would be 25 basis points. Bank of America-Merrill Lynch analysts said the sudden surge in the short-term money markets was the result of the PBoC mishandling a sharp rise in demand for liquidity. Demand for money always rises suddenly in China during national public holidays. "A sharp rise in interbank rates disturbs financial markets, which are already quite fragile," the analysts said. It is most likely that the PBoC failed to anticipate and then failed to respond swiftly to the sudden fall in liquidity supply and seasonal demand for liquidity. Economists believe the rising yuan, which has been allowed to appreciate by 15 per cent this year against the US dollar, also helps the case for an interest rate cut.