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The author is a researcher with the Institute of Finance and Banking at the Chinese Academy of Social Sciences

On March 17, the People's Bank of China, the central bank, announced a 0.27 percentage point hike in key interest rates. This was dictated by current major economic indicators.

Macroeconomic readjustment policies in 2006 seem to have not worked effectively to put a brake on runaway real estate prices.

SOHO China chairman Pan Shiyi(L) said "The rise will have little effect on home prices in general and people won't suspend purchases because of it." Economist Yi Xianrong said even small interest rate rise can cool housing.

If housing prices keep rising rapidly, the ongoing increase in property investments is not expected to slow. As a result, overheated fixed asset investment will continue and, in turn, ever expanding bank loans will keep gaining momentum.

In addition, the banks are feeding growing real-estate investments with their readiness to make loans.

Starting from the latter half of 2006, the central bank, confronted with overheating investment, rapid growth in bank loans and increasing trade imbalances, implemented a host of macroeconomic readjustment policies. To slow growth in bank loans, the central bank raised the deposit reserve ratio and required market operations to be more transparent.

However, these policies had limited effect.

Related readings:  Yuan opens trading day at post-revaluation high  China likely to hike interest rates again in 2nd quartere  Rate rise a bad news for real estate sector  Public housing fund rate rises 18 basis points

The price mechanism is at the core of the market infrastructure. This means that the relationship between supply and demand is modulated by the price.

In the monetary market, the price of capital is nothing more than the interest rate. The price mechanism works in the form of interest rates' ups and downs.

In China, whose economic set-up is still in transition from the planned economy to a market oriented one, the price mechanism is still at the core of the general economic operation.

Currently, many problems in the Chinese economy have their roots in the low-interest-rate policy. It leads to overheating in fixed asset investment and excessive growth in the country's favorable trade balance.

In the context of low interest rates, it is profitable for investors to borrow money from the bank. The investors, who borrow low-cost money, feel no restraint in investing in high-risk projects. The capital easily flows into economic operations, particularly real estate and the stock market. Under such circumstances, it is only natural that stock and real estate prices keep soaring.

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