China's moves to restrain its hot economy are sending chills throughout the rest of the world, raising fears that a slowdown in the country's rapid growth could crimp the global recovery.
China's economy is key to world trade, and any move to curb growth sends jitters through financial markets as investors worry about reduced demand from the fast-growing nation.
New Chinese restrictions on bank lending soured stock markets Wednesday, knocking commodities such as oil, copper and gold lower, while commodity-linked currencies like the Canadian dollar fell sharply in step.
The focus on China comes at a crucial time as global economies climb their way back from one of the most brutal recessions in history.
Most economists say the world has left the recession behind and is in the early stages of a growth period.
But the drop in commodities serves as a reminder that the world's emergence from the downturn will be slow and uneven.
"This was a reality check," particularly for commodity prices, "which got well ahead of themselves," said Nariman Behravesh, chief economist at global consultants IHS Inc. in Lexington, Mass.
"The relatively lacklustre nature of the recovery, and the fact there are still a lot inventories, mean demand for some commodities including oil didn't justify the kind of price increases we've seen in the last few months," Mr. Behravesh said.
China's banking regulator this week ordered some banks to limit their lending and revealed plans to cap credit growth in the country. Those measures follow another last week in which China's central bank, for the first time in 18 months, increased the share of deposits that lenders have to set aside as reserves.
"People are recognizing that there are some imbalances in the Chinese economy that couldn't be ignored forever, and the Chinese government is beginning to have to take more account of those," said Martin Evans, an economics and finance professor at Georgetown University in Washington.
Fears about the strength of the U.S. recovery resurfaced, because a slower Chinese economy would likely mean less demand for U.S. exports. As a result, investors dumped stocks in favour of "safe havens" such U.S. government bonds and the U.S. dollar.
And the Canadian dollar, whose value is closely linked to commodity prices, dropped about one and a half U.S. cents to close at 95.51 U.S. cents.
The loonie also fell because of tame inflation data that showed Bank of Canada Governor Mark Carney has little reason to raise rock-bottom lending rates any time soon. Canadian consumer prices rose a less-than-expected annual rate of 1.3 per cent in December from a year earlier after a 1-per-cent pace in November, Statistics Canada said Wednesday. Less volatile "core" prices, which the Bank of Canada monitors as a guide to future inflation, rose 1.5 per cent.
Meanwhile, Statscan said manufacturing sales were at a virtual standstill in November, which does little to fill the excess production capacity in the economy that Mr. Carney says will persist well into next year.
For the Canadian dollar, "we're in a weaker-than-expected rut here," said Firas Askari, head of currency trading at BMO Nesbitt Burns Inc. "Many peoples' expectations on the commencement of Bank of Canada hikes might have been pushed back."
Still, the underlying trend is that high commodity prices and Canada's relatively solid fiscal position will continue to boost the currency eventually, he added. Finance Minister Jim Flaherty touted Canada's fiscal health - relative to other Group of Seven economies - and the U.S. dollar's decline against other major currencies over the past year as reasons why Russia's central bank and other policy makers are investing in Canadian securities and the loonie.
While inflation remains under control at home, it's picking up in China and much of Asia. In the U.S., the inflation rate hit 2.7 per cent last month, while the U.K. rate quickened to 2.9 per cent, the biggest increase on record.
"Canada is marching to its own tune here," said Patricia Croft of RBC Global Asset Management. "It's very much out of step with what's happening with other countries around the world, and directly related to the strength of the Canadian dollar."
Indeed, other reports Wednesday painted a bullish picture of some key economies. In the U.S., housing starts fell in December as a result of unseasonably cold weather, but construction permits rose 11 per cent to the fastest annual pace in more than a year. And in Britain, the last major advanced economy that hasn't seen a return to growth, unemployment dropped at the fastest clip since 2007.
IHS's Mr. Behravesh pointed to those developments as signs the global recovery is sustainable, even if commodity prices fall some more to bring them in line with "fundamentals." And, he said, China won't "put the brakes" on its economy to such an extent that it threatens a worldwide rebound.
The Bank of Canada, which on Tuesday left borrowing costs near zero, said that while core prices are slightly higher than expected, it is sticking to its pledge to keep rates on hold through June, provided the outlook for inflation returning to its 2-per-cent target doesn't change.
"Even in a recovery, inflation does not seem to be a problem for Canada," said Krishen Rangasamy, an economist at Canadian Imperial Bank of Commerce. "Excess capacity and the strong currency are allowing Canadians the benefit of low prices, and therefore low interest rates for longer."
With a file from Bloomberg