Inflation figures for July will be published on Thursday by China’s National Bureau of Statistics and investors in the markets, as well as economists, are watching to see whether they will give the People’s Bank of China (PBOC) room to loosen monetary conditions even more.
China’s Consumer Price Index (CPI) fell to 2.2 percent year-on-year in June, the lowest in 29 months and well below the government’s target of 4 percent for this year.
The fall was helped by a much slower increase in food prices compared with the same period last year. According to High Frequency Economics economist Carl Weinberg, overall food prices in China’s June CPI report rose just 3.8 percent year-on-year compared with a jump of 14.8 percent in June last year.
Qinwei Wang, China economist at Capital Economics, believes prices will continue falling in July, with slower food inflation helping to bring down the overall index, but some risks remain.
“They will have help, at least for July, for inflation to fall further,” Wang told Emerging Markets. “But because of the recent strength of the global food prices there are some risks.”
China is a big importer of soybeans, whose prices have been rising lately as a prolonged drought in the U.S. – the world’s biggest grower - and Eastern Europe damaged crops.
“But so far if you look at the year-on-year inflation of soybean prices, it’s not as high as last time. It’s still a smaller scale than the previous hike in inflation,” Wang added.
FOOD PRICES BOTTOM
Societe Generale’s China economist Wei Yao expects China’s inflation to fall further in July to 1.7 percent year-on-year, implying a zero month-on-month change after three consecutive declines, but food prices are on the rise.
“Food prices seem to have formed a bottom and have been creeping up since the start of July. The wholesale food price index, tracked by the Ministry of Agriculture, was up 3.6 percent between the beginning and end of the month,” Yao wrote in a market note.
The effect of rising food prices might be mitigated by low price pressures elsewhere. Recent PMI surveys have shown that producers are “still cutting prices,” Wang said, and with industry prices very low, some impact of a potential rise in agricultural prices will be offset.
Producer prices will be released at the same time with CPI and Yao expects them to fall 2.4 percent year-on-year, because of “the continued impact of deleveraging and destocking in sectors that suffer from excess capacity.”
This will give more room for maneuver to the PBOC, which has cut banks’ reserve requirement ratio (RRR) three times since November last year and has reduced interest rate twice to avoid a hard landing because of the impact of the slowdown in the eurozone and the U.S.
Another beneficial effect of falling inflation would be, according to some economists, increased consumption in China. High Frequency Economics’ Weinberg blamed the acceleration of food prices in 2010 and last year for “a squeeze on real incomes that has braked the economy.”
“Our confidence in a consumer-led rebound of GDP growth back towards it 9.8 percent potential rate will be supported by a friendly CPI report this week,” he wrote in a market note.
LOW CONSUMPTION
China’s growth figure disappointed last month, with official GDP data showing the economy advanced at just 7.6 percent in the second quarter, the slowest pace in three years.
Capital Economics’ Wang warned against pinning too many hopes on falling inflation to boost disposable income and therefore growth.
“In China consumption is a very small part of the economy,” he said. “The Chinese economy is heavily relying on investment. I think that’s a more important factor than the impact on consumption.”
But lower inflation will allow policymakers to focus on growth as it will make room for monetary easing and fiscal spending, Wang, who expects one more rate cut and three more reductions in China’s RRR, told Emerging Markets.
Last week, the Chinese Communist Party’s policymaking committee, the Politburo, reiterated its position that China will pursue a “proactive” fiscal policy and “prudent” monetary policy and that maintaining growth was its top priority, Bloomberg reported citing official news agency Xinhua.
The Communist Party will hold its 18th congress later this year when there will be a change in leadership.
“The new generation of leaders will have to deal with issues of both economical and political sustainability,” Barclays Capital analysts wrote in a market report.
They said the transition will probably generate only “a limited period of policy slack” as the new leaders were already within the decision-making mechanism, but warned that their priorities might be slightly different.
“The new leaders are probably less ’growth minded’, and likely more focused on rebalancing the economy and structural reforms, with particular emphasis on urbanization, the service sector and promoting balanced regional development,” the Barclays Capital analysts wrote.