China announced that it is increasing interest rates for the first time in three years, likely out of fear of inflationary pressure, especially in the housing market . The New York Times has some good background on how analysts are interpreting a move which is already "roiling" markets, hurting oil prices and strengthening the dollar.
Some analysts said the rate increase also suggested a deal was in place between China and the United States to strengthen the yuan and put an end to worries about a currency war of competitive devaluations ahead of upcoming Group of 20 meetings.
But others said just the opposite was the case -- with higher rates, Beijing can afford to rely less on currency appreciation to keep the economy on an even keel...
Higher rates make yuan-denominated assets more attractive and could in theory place upward pressure on the Chinese currency. Until a fall on Monday, the closely managed currency had risen 2.5 percent against the dollar since the end of August, its quickest pace of appreciation since a 2005 revaluation.
And Krugman explains why there's a difference between the United States' strategy of expansionary monetary policy (which weakens the dollar slightly) and China's strategy of weakening the RMB (which forces the government to pursue a contractionary monetary policy).
The United States is pursuing an expansionary domestic monetary policy, which increases overall world demand; however, a side consequence of this policy is a weaker dollar. China is pursuing a weak-yuan policy; to counter the inflationary domestic effects of that policy, it's pursuing a contractionary domestic monetary policy, reducing overall world demand.
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