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FOREX FOCUS: Growing China Threat To Global Risk

13 Dec 2010, 13:05

By Nicholas Hastings

A DOW JONES NEWSWIRES COLUMN

LONDON (Dow Jones)--Slower growth in China will almost certainly bring a nasty

reassessment of global risk sentiment.

Moreover, fears of a hard landing in that country will bring an even more

violent shift in risk.

Fears of a hard landing emerged over the weekend as Chinese inflation soared to

5.1%, its highest level in two years.

This happened despite repeated attempts by Beijing to cool the country's

overheating economy this year with a combination of limited rate rises and a

succession of six increases in bank reserve requirements that are now close to

20%.

The strong inflation numbers, combined with sharp rises in retail sales, import

growth at the fastest rate in six months and a rapid increase in money supply in

the past few days suggest that past policies haven't worked.

All the same, there is little sign that the People's Bank of China is in a hurry

to accelerate the pace at which it is tightening monetary policy.

On the contrary, the central bank failed to increase interest rates again as

expected over the weekend with officials suggesting that they will continue to

pursue a "cautious" policy.

As far as financial markets are concerned, China's decision to keep rates

unchanged for now means that global growth prospects will continue to improve.

After all, as long as Chinese demand for U.S. and European goods remains strong

and commodity prices remain high, global investors will remain more relaxed

about putting their funds in riskier, higher-yielding, markets.

This was evident in a rise in commodity currencies, such as the Australian

dollar, and a rally in Asian stocks.

However, any sign that the PBOC is becoming more aggressive about tightening

rates and that China's economic expansion is about to slow even more rapidly

could bring an immediate change of investor heart.

The key problem is whether any slack in global growth prospects created by a

slower China can be taken up by the recovery in the U.S. and the euro zone.

If not, then the overall global outlook will be downgraded once again, driving

investors back into safe havens as they reassess their appetite for more risky

markets.

There is, though, another scenario that could prove even more damaging for

risk--a Chinese central bank that continues to dither for fear that higher rates

will accelerate capital inflows and make matters worse.

If that is the case, continued overheating will raise the risks of a so-called

hard landing, in which the PBOC is forced to raise rates at a more rapid pace to

stop inflation getting out of hand.

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The consequences for Chinese growth, as well as that of the global economy,

could be even more alarming.

As investors downgrade their outlook, they could lose their appetite for risk

even more rapidly, putting currencies such as the safe-haven dollar firmly back

in favor.

Bloomberg TNI FRX POV

Reuters USD/DJ

Thomson P/1066 or P/1074

December 13, 2010 07:05 ET (12:05 GMT)