Increasing inflation risks have fuelled market expectation of a new interest rate hike to prevent the national economy from overheating.

Economists believe that higher consumer price index (CPI) inflation, in addition to concerns on rapid loan expansion, will push the central bank to further tighten monetary policies.

"If the actual CPI inflation exceeds 3 percent, we believe it could be a stress test on the People's Bank of China's comfort zone for inflation," Liang Hong, chief China economist with Goldman Sachs, said.

Economic data for the first quarter has yet to be released, but observers at home and abroad have already revised upwards their forecasts for GDP growth.

"Continued inflationary pressures have increased the risks of another sooner-than-expected interest rate hike and/or reserve requirement ratio hike," Liang said.

China's CPI, the main inflation gauge, grew by 2.7 percent year on year in February, 50 basis points more than in previous months.

But the country's strong growth momentum indicates that inflationary risks are on the upside.

The economy grew 10.7 percent to 20.9 trillion yuan (US$2.7 trillion) last year, the fastest rate since 1995.

In spite of a spate of tightening measures to keep the pace of expansion in check, the economy still registered another strong start this year: in the first two months, almost all major economic data rebounded significantly.

Industrial production, urban fixed-asset investment and industrial profits increased by 18.5 percent, 23.4 percent and 43.8 percent, respectively.

Underpinning such strong growth in real sectors were fast bank lending growth and increased money supply driven by a surge in foreign exchange reserves.

"An interest rate hike is now just a matter of time," Stephen Green, a senior economist with Standard Chartered, said, citing concerns about asset price inflation.

The People's Bank of China, the central bank, raised interest rates on March 18.

Yet, the country's real interest rates as measured by deposit rates minus the inflation rate have now become negative. And that is believed to be an underlying driving force in the boom of domestic equity markets that continue to reach new highs nowadays.

While agreeing that inflation will be high, not all economists think the central bank will have another interest rate hike.

"We expect CPI inflation to rise to 2.5 percent in 2007 from 1.5 percent in 2006, as a result of recent surges in food prices," Sun Mingchun, an economist with Lehman Brothers, said.

But Sun expects that the CPI will decline in the second half of this year and thus there will be no further rate hikes in 2007.

(China Daily April 17, 2007)