The latest rise in China’s inflation rate immediately spurred predictions of tighter credit by the People’s Bank of China. Yet, higher rates might not have the kind of dampening impact they would elsewhere, in particular on the frothy property sector.

Shortly before China said Friday that its consumer price index rose a higher-than-expected 5.4% in March, Premier Wen Jiabao said food, labor and housing costs mean “we are still under great pressure.” In carrying the premier’s pledge to remain vigilant, the state-run Xinhua news agency termed home prices as “runaway.”

Though a small component of the consumer price index, home prices are among the primary causes and risks of soaring inflation in China. Unaffordable housing is also a threat to social stability.

Economics theory dictates that higher rates would damp prices by signaling to prospective home buyers that they will face higher mortgage payments and should stick to the sidelines.

Now, a study quantifies how that’s not the way it works in China, where tighter credit may actually spur higher prices.

Each credit-tightening move by the People’s Bank of China between June 2005 and September 2010 has been accompanied by a 5% rise in annual home prices, according to a study published by the University of Nottingham’s China Policy Institute. In other words, for every 0.5-percentage-point rate increase, property prices were 5% higher a year later.

“Instead of running away from the market, investors rush to buy houses or shares whenever tightening monetary actions are taken,” write the study’s authors, professors Yao Shujie, Luo Dan and Loh Lixia.

Chinese real estate trends carry world-wide implications.

In a mid-March report, UBS economist Jonathan Anderson described Chinese property as “the single most important sector in the entire global economy,” “pervading” the country’s economy and driving factors like the price of copper.

A few days later, Wang Tao, a Beijing-based colleague of Mr. Anderson’s at UBS, said in a separate report that risks are “very high” China could experience a property bubble in coming years. To gauge it, Ms. Wang said, “Most importantly, given the poor quality of the price-related data, we should watch closely construction activity and credit expansion.”

It’s well known that interest rates have a limited impact on China’s credit, primarily because the financial system lacks market mechanisms to ensure higher borrowing costs actually crimp credit growth. Indeed, China’s monetary policy itself isn’t solely an economic consideration.

These facts help explain why Beijing often backs up monetary policy changes with rhetoric, such as tough talk from Mr. Wen.

“The message from the central government is very clear. The government is trying to control speculation and investor demand,” J.P. Morgan’s China Chairman Jing Ulrich told the Australian Chamber of Commerce in Shanghai this week.

But, like the Nottingham study notes, Ms. Ulrich highlighted how housing prices have risen even as bank credit has tightened. At 20%, the prevailing “reserve ratio” means big banks need to park 20 cents of every dollar they have on deposit, she said. That represents a significant choke on their scope to lend—but still home prices soar.

Central parts of Beijing’s plan to control housing prices, she noted, aren’t rate-related: taxes, targets, plus plans to build 36 million “affordable” apartments in the just-adopted five-year plan.

The authors of the Nottingham paper use the word “irrational” 11 times in 34 pages to describe how the investment psychology of Chinese citizens frustrates the workings of monetary policy.

Yet, the paper also explains roots of the behavior: “Rapid urbanization, attitude towards home ownership, lack of investment channel and imperfect market competition are some of the key factors responsible for large stock market and housing bubbles,” it says.

“Apart from acting early and more aggressively, the Chinese government should try to create more investment channels, to promote a fairer and better free-market system, to shift its economic structure, which will depend less on investment and more on effective domestic consumption,” it says.

China’s monetary policy mechanisms might be imperfect, but they are needed to tackle the problem.

–James T. Areddy. Follow him on Twitter @jamestareddy

Measured on a purchasing power parity (PPP) basis that adjusts for price differences, China in 2009 stood as the second-largest economy in the world after the US, although in per capita terms the country is still lower middle-income.

The government vowed to continue reforming the economy and emphasized the need to increase domestic consumption in order to make China less dependent on foreign exports for GDP growth in the future.

The government has also focused on foreign trade as a major vehicle for economic growth.

Some economists believe that Chinese economic growth has been in fact understated during much of the 1990s and early 2000s, failing to fully factor in the growth driven by the private sector and that the extent at which China is dependent on exports is exaggerated.

China is the world’s largest producer of rice and is among the principal sources of wheat, corn (maize), tobacco, soybeans, peanuts (groundnuts), and cotton.

China has acquired some highly sophisticated production facilities through trade and also has built a number of advanced engineering plants capable of manufacturing an increasing range of sophisticated equipment, including nuclear weapons and satellites, but most of its industrial output still comes from relatively ill-equipped factories.

China’s ongoing economic transformation has had a profound impact not only on China but on the world.

China now ranks as the fifth largest global investor in outbound direct investment (ODI) with a total volume of $56.5 billion, compared to a ranking of 12th in 2008, the Ministry of Commerce said on Sunday.

“China is now the fifth largest investing nation worldwide, and the largest among the developing nations,” said Shen Danyang, vice-director of the ministry’s press department.

It also aims to sell more than 15 million of the most fuel-efficient vehicles in the world each year by then.

China’s challenge in the early 21st century will be to balance its highly centralized political system with an increasingly decentralized economic system.

Agriculture is by far the leading occupation, involving over 50% of the population, although extensive rough, high terrain and large arid areas – especially in the west and north – limit cultivation to only about 10% of the land surface.

In terms of cash crops, China ranks first in cotton and tobacco and is an important producer of oilseeds, silk, tea, ramie, jute, hemp, sugarcane, and sugar beets.

Sheep, cattle, and goats are the most common types of livestock.

China is one of the world’s major mineral-producing countries.

There are large deposits of uranium in the northwest, especially in Xinjiang; there are also mines in Jiangxi and Guangdong provs.

In the 1990s a program of share-holding and greater market orientation went into effect; however, state enterprises continue to dominate many key industries in China’s socialist market economy.

Other leading ports are rail termini, such as Lüshun (formerly Port Arthur, the port of Dalian), on the South Manchuria RR; and Qingdao, on the line from Jinan.

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Higher Interest Rates Might Push Up Property Prices