Markets spooked by breakneck Chinese growth

Fears that China's breakneck economy is overheating rattled stock markets around the world yesterday. The world's fourth largest economy expanded at 11.1 per cent annual pace in the first three months of this year, an acceleration from 10.4 per cent growth in the previous quarter.

Growth was fuelled by rapid investment and booming exports, with a series of recent tightening measures apparently doing little to restrain activity.

Inflation picked up to 3.3 per cent - the first time it has gone above 3 per cent in more than two years. Analysts said the news would prompt China's central bank to raise interest rates again, and force banks to keep more money in their reserves rather than lending it out.

The prospect of higher borrowing costs and worries that China's boom could rapidly turn to bust pummelled Far East stock markets. China's main share index, the Shanghai Composite, dived 4.5 per cent, the biggest one-day drop since the global sell-off at the end of February. However, it remains 29 per cent above its level at the start of the year. Hong Kong shares were down 2.3 per cent, while those in Singapore fell 3.2 per cent.

In London, the blue-chip FTSE 100 tumbled more than 60 points before recovering its poise to close 8.8 points lower at 6,440.6. On Wall Street, the Dow, which hit record highs on Wednesday, added 4.8 points to 12,808.6.

On currency markets, the yuan touched 7.7160 to the dollar, its highest since it was revalued and freed from its peg to the greenback in July 2005. The Japanese yen rose sharply as risk-averse traders unwound carry trade positions, hitting high-yielding currencies including the pound. Sterling dipped below $2 before finishing the day at £2.0085.

Copper prices fell 4 per cent as investors anticipated that attempts to slow China's economy would hit demand for raw materials. Other industrial metals such as nickel and tin were hit.

Chinese Premier Wen Jiabao said Beijing needed to rein in the economy. "We need to prevent the economy from shifting from relatively fast growth to a state of overheating and to prevent big ups and down," he said in a statement posted on the government's website. "We will work hard to keep basic stability in the overall level of prices."

Upgrading his 2007 growth forecast from 9.6 to 10.6 per cent, Stephen Green, a senior economist at Standard Chartered in Shanghai, said: "This economy is not landing - it has re-fuelled mid-flight and is flying higher again."

He predicted two more rate hikes this year, taking borrowing costs to 6.93 per cent.

Mr Green also suggested growth might be even stronger than the picture painted by the official figures. Adding up the provincial data pointed to growth of 13.6 per cent, he said.

China's economic performance has been extraordinary. It has almost doubled its output in five years, riding an unprecedented wave of industrialisation, urbanisation and inward investment, the latter galvanised by its accession to the World Trade Organisation in 2001. It is on course to overtake Germany in 2008 as the world's third largest economy and is tipped to surpass the US by 2025. News that the economy started 2007 as it finished 2006 came just days after renewed calls from the Group of Seven industrialised nations for China to increase its currency flexibility. China only allows the yuan to trade in a very narrow range against the dollar, but has long pledged to allow it to trade more freely. In the meantime, by refusing to let its currency rise to reflect the economy's strength, China is ensuring its exports are cheaper and providing a big boost to growth.