Over the weekend the Chinese government revealed that the country’s inflation rate had hit 5.1%, considerably higher than expectations of around 4.7%. An interest rate hike was expected to follow, but it did not. That non-news has put some energy back into the country’s equity markets, especially the Shanghai Composite Index, which rose almost 3%.

Late last week the government upped the required reserve ratio for the country’s banks by 50 basis points, putting the rate paid required at the largest banks at 19% of deposits. And as far as interest rate hikes go, MarketWatch cited a Citigroup note stating that an interest rate hike of 0.25% was already priced in to equities.

The Chinese government is reluctant to boost interest rates because that would almost surely cause money flows into the country to rise, adding more fuel to the inflation fire that is building. It seems that inflation fears are being trumped by the government’s desire to keep the country’s economy growing.

Perhaps the most rapidly rising Chinese stock belongs to Baidu, Inc. (NASDAQ: BIDU), the Chinese search engine provider. The company held about 73% of the search market at the end of the third quarter and its stock price has soared by about 150% in the past twelve months.

Compare that growth with China Mobile Limited (NYSE: CHL), the country’s largest mobile phone company, which has risen by about 10% in the past year. Or China Petroleum & Chemical Co., known as Sinopec, (NYSE: SNP) which has grown by less than 10%.

Sinopec is more than twice the size of Baidu, as measured by market cap, and China Mobile is larger than Sinopec. But Baidu is viewed as the dominant player in its market, even though search engine revenue for all companies in China is likely to be less than $2 billion in 2010. Google Inc. (NASDAQ: GOOG) had about 25% of China’s search engine market in the third quarter, but its wrangling with the government has given Baidu a big shot in the arm.

Though the markets took comfort from the Chinese government’s inaction over the weekend, all is not really well in the country’s equity markets. The government has declared that its top priority for 2011 is to stabilize prices without stunting economic growth. But the country’s loose monetary policy has pumped billions of yuan into the economy and helped inflate bubbles, particularly in real estate.

The government has decided to tighten monetary policy going forward, but has offered no specifics. The lending target for 2011 has been set at 7 trillion yuan, down from 7.5 trillion yuan in 2010 and 9.6 trillion yuan in 2009. That could help a little.

But the government appears to be searching for a precision tool that does not include interest rate hikes or currency revaluation as a means to rein in inflation and maintain economic growth. If it finds one, then Baidu and China Mobile are likely to benefit. Sinopec and other Chinese oil companies are not, because the government will almost certainly have to do something to tamp down rising gasoline prices for Chinese consumers.

Today’s good news in China’s equity markets is likely to be temporary. Once the government decides how it plans to deal with inflation, equity markets are not likely to applaud the outcome.

Paul Ausick

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