Governor of the People's Bank of China Zhou Xiaochuan speaks at the opening ceremony of the annual meeting of the boards of governors of the African Development Bank Group in Shanghai May 16, 2007. [Reuters]

China raised interest rates and bank reserve requirement ratio on Friday in the latest effort to prevent the economy from overheating.

That marked the first simultaneous use of the two monetary tools in a decade, as well as the eighth increase in reserve ratio since last July and fourth interest rate hike since last April.

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The benchmark one-year deposit rate will be increased by 0.27 percentage point while the one-year lending rate will rise 0.18 percentage point starting from Saturday, the People's Bank of China said in a statement on its website.

After the announcement, the one-year deposit rate stands at 3.06 percent, slightly higher than the consumer price index growth of 3 percent in April. The one-year lending rate is now 6.57 percent.

The banks' reserve requirement ratio will be raised by 0.5 percentage points to 11.5 percent, effective from June 5, the central bank said.

The tightening measures came after a series of economic data suggested that the world's fourth largest economy is evolving towards overheating.

The gross domestic product grew 11.1 percent in the first quarter of the year while urban fixed asset investment soared 25.5 percent, official statistics showed.

Banks extended 422 billion yuan in new loans in April, bringing the amount for the first four months to 1.85 trillion yuan - more than half the total for the whole of 2006.

Inflation, measured by the consumer price index (CPI), grew three percent in April, barely meeting the central bank's target.

CPI growth not to slow down

The interest rate hike is not unexpected, said economist Wang Xiaoguang. "However, the increase of interest rates and bank reserve ratio at the same time is the first in this round of macro economic control."

This indicated macro control by the government is strengthening to prevent the economy from becoming overheated, said Wang.

Ha Jiming, chief economist of China International Capital Corporation expected the tightening to produce some effects, albeit limited.

However, the interest rate hike can hardly slow down the pace of CPI growth in the coming months, said Ha, citing the rise in grain and resource prices.

Limited influence on stock market

Most economists believed the new measure does not target the stock market which has soared 50 percent so far this year on top of a 130 percent rally in 2006, prompting concerns about bubbles.

"The central bank move does not mean to crack down on the stock market," said Xia Bin of the Development Research Center under the State Council. "It mainly addresses excessive liquidity in the macro economy."

However, the tightening is sure to have some negative influence on the equity market, noted Xia. But the impact may be small, said Liu Jipeng of China University of Political Science and Law.

Even after the rise, the deposit interest rate in the country is still low, explained Liu. Therefore, the diversion from bank deposits to stock market will not stop.

On the stocks that will be more adversely affected than others, Liu Yihui of the Chinese Academy of Social Science points to bank shares while Ha Jiming picked industries with a high debt ratio.

The increase of deposit rate is bigger than the rise in lending rate, hereby reducing the banks' interest spread and thus affecting their profit from lending, explained Liu.