The Chinese government has been battling with a stubborn inflation rate for some months now. In December 2010 it announced that the consumer price index had risen to 5.1 per cent from 4.4 per cent in October and whilst prices slowed in December to 4.6 per cent they are expected to speed up again to 5.3 per cent in January.

To try and combat inflation, the People's Bank of China increased interest rates by raising its one-year lending rate by a 25 basis points (25/100ths of 1 per cent or a quarter of a per cent) to 6.06 per cent. The increase has not been unexpected and many economists expect China to increase interest rates again later this year. The interest rate increase comes on top of the move to increase reserve requirements for banks to 19.5 per cent in a move to cut bank lending.

Steps are also being taken to try and increase the savings ratio in the country. Interest rates on deposits were increased by up to 45 basis points.China already has a high marginal propensity to save (MPS) in comparison to other countries around the world but increasing it further will help to reduce some inflationary pressures. Guonan Ma and Wang Yi in a paper published in 2010 (China's high saving rate: myth and reality - Bank for International Settlements) estimate the MPS at over 50 per cent.

Despite this it is expected that inflation will increase faster in the coming months due to the effects of rising food, energy and commodity prices. One of the problems facing China, along with other countries around the world, is that inflationary pressures are being driven by these external factors and increasing interest rates is not necessarily going to have any major effect on these drivers.