China raises benchmark rate to fight inflation

China raised its benchmark interest rate Wednesday for the third time this year as it struggles to tame inflation that could threaten social and political harmony in the world's second biggest economy.

The central bank announced that the benchmark rate for one-year loans would be raised 0.25 percentage points to 6.56 percent starting on Thursday.

Reuters reported that the rise demonstrated China's confidence that the world's second-biggest economy is resilient enough to cope with tighter monetary policy without the risk of a hard landing that some investors fear.

(From GlobalPost in China: Rocky times ahead in South China Sea) 

Nevertheless it said some assets linked closely to the Chinese economy, such as the Australian dollar, were sold after the announcement due to fears the Asian giant would be unable contain inflation and maintain growth rates amid global economic uncertainty.

With U.S. interest rates near zero, Beijing worries it might attract more speculative funds into China if it raises rates too far. That would exacerbate the problem of excess liquidity and further fuel inflation.

Equally, it has to placate depositors struggling with a negative real rate of return on their cash in banks.

Higher food prices and an overheated property market saw China's inflation rise to a 34-month high of 5.5 percent in May.

Other tools at the government's disposal to fight inflation, such as investment curbs, have cooled the economy but there are concerns more interest rate hikes could lead to a broader downturn.

The rate hike also will add to the debt servicing burden of local governments, which have piled up $1.6 trillion in debt according to a recent official report, the AP reported.

News of the rate hike in China, a key driver of the global recovery, helped drag European stocks lower and cast a pal over the opening on Wall Street.