China tries to control stock market balloon

China has taken its first decisive step to deflate a dangerous bubble building in its stock market.

The central bank announced late on Friday that it was raising benchmark lending and deposit rates, lifting bank reserve ratios and widening the yuan’s trading band, its strongest package of steps since it began tightening policy a year ago.

Equities may fall sharply early next week, but fund managers and analysts expect a correction rather than a crash.

“You will see a correction in the market, possibly a sharp one,” said Zhu Ping, chief investment officer at GF Fund Management, which manages over 3.9-billion.

“Banks will be among the biggest losers on Monday. Their business relies too much on lending. Investors have been worried about that for a long time,” he said.

A fevered bull run has taken Shanghai’s composite index up 51% this year, after 130% last year, while daily turnover has ballooned to as much as 10 times year-earlier levels.

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In our view, the Chinese stock market is very overvalued, and there is significant downside risk in that market.