Fears are mounting that China's economy could be overheating, amid rising inflationary pressures. This follows the announcement that inflation reached a 28-month high of 5.1% year on year in November. Talk of measures to help to stabilise prices dominated the agenda of the government's annual Central Economic Work Conference, which set policy goals for 2011. After the meeting had concluded on December 12th, a policy statement spoke of a shift from "appropriately loose" monetary policy in 2010 to "prudent" policy in 2011. This underscored the fact that the government is strengthening its focus on tackling inflation and keeping liquidity growth under control.

The People's Bank of China (PBC, the central bank) has traditionally tried to keep prices and liquidity in check using quantitative controls on monetary and credit expansion. Given the government's ability to control credit expansion through the state-owned banking sector, quantitative controls are as important in policy terms as the lending interest rate. The PBC has raised banks' reserve requirements six times in the past year; the most recent rise, on December 10th, was the third in a month, taking the ratio for big banks up to 18.5%. In contrast, the benchmark lending rate has been raised just once in 2010. Given the fact that real interest rates on one-year deposits in China are now negative, and that worries are growing with regard to rising inflation, the probability of more rate rises early next year is increasing.

The Chinese authorities' fears that inflation could accelerate further were not helped by the decision in November by US authorities to launch a fresh round of quantitative easing. The decision by the Federal Reserve (the US central bank) to begin a new phase of quantitative easing in effect signals that it is preparing to keep interest rates at their current, ultra-low levels for some time to come. This has fuelled concerns that there could be a flood of hot money from the US to faster-growing parts of the world economy, such as China, in search of higher returns.