China’s consumer price inflation (CPI) for July was slightly higher than consensus expectations but the lowest in 30 months. Consumer prices were up by 1.8 percent year-on-year in July, a slower increase than July’s 2.2 percent and May’s 3 percent.
Analysts had expected prices to rise by 1.7 pe rcent in July but most still think the People’s Bank of China (PBOC) should go ahead with measures to ease monetary policy such as reducing interest rates or cutting banks’ reserve requirement ratio (RRR).
“Inflation is roughly in line with expectations. It suggests that policymakers can still focus on growth,” Qinwei Wang, China economist at Capital Economics told Emerging Markets.
The base effect – in this case, much higher food price inflation in the same period last year skewing this year’s calculation to show lower figures – has an important role to play, as it may mean that inflation will rise in future months, analysts said.
“If you look at the breakdown you can see that food inflation continued to fall. But that was because of the base effect,” Wang said.
“In the coming months, that base effect will change course. Food prices will stop falling in real terms and this will lead to higher inflation. But we think that in general prices pressure still look very low. I think the policymakers will feel comfortable to continue to ease policy and support the economy.”
Asian stock markets closed higher and the Australian dollar firmed after the data.
“The headline figure may have disappointed expectations for a slightly lower reading but it has buoyed forecasts for further easing from the PBOC,” Eimear Daly, FX Market Analyst at Monex Europe, wrote in a market note. “AUD/USD couldn’t contain the risk-on sentiment and broke out to the upside. AUD continues to trade as a proxy for a Chinese hard landing.”
CPI AND PPI DIVERGE
The Australian dollar was also boosted by Australian employment figures for July, which beat expectations while the jobless rate fell to 5.2 percent.
Societe Generale’s economist Wei Yao pointed towards the divergence between consumer and producer prices – with the latter falling – to highlight the Chinese central bank’s dilemma.
Producer prices fell by 2.9 percent in July versus expectations of a 2.5 percent dip, with producer goods prices down nearly 4 percent year-on-year. The divergence, Yao said, indicates that manufacturers of upstream materials such as steel “continue to suffer from massive excess capacity and severe margin compression.”
“The divergence between the two inflation indicators highlights a dilemma for the central bank,” Yao wrote in a market note.
“Should the PBOC focus more on maintaining a positive real deposit rate for households or on alleviating the pain felt by sectors with excess capacity? We think the PBOC will try to strike a difficult balance by keeping benchmark interest rates unchanged and, at the same time, easing liquidity conditions to lower costs of capital indirectly.”
Some market commentators said the recent drought in the U.S. – the worst in 50 years – could result in a surge in grain prices that would spill over into China’s inflation.
But economists from Bank of America Merrill Lynch argued in a recent report that the surge in U.S. grain prices will have a limited impact on China’s food price inflation.
FURTHER INTEREST RATE, RRR CUTS
Chins is still “relatively self-sufficient” on grains, as imports make up only 9.5 percent of total food consumption; almost all of China’s food imports are soybean but 57 percent of them come from outside the U.S. despite the country’s status as top world producer and the response of pork prices to feed grain price shocks has historically been quite slow, the Bank of America Merrill Lynch economists said.
“It is just too early to cite inflation risks, and in our view, further cuts to the reserve requirement ratio (RRR) and interest rates are needed to bolster growth in China,” they wrote.
Bank of America Merrill Lynch expects the PBOC to cut RRR three times (by a total of 150 basis points) and interest rates two times (50 basis points in total) before the end of the year.
Industrial production figures for July were also released on Thursday and the data showed industrial output expanding at 9.2 percent, slower than a previous expansion of 9.5 percent and below market expectations of 9.7 percent.
Retail sales were up 13.1 percent from a previous rise of 13.7 percent and against expectations of a 13.5 percent rise.
The data, although slightly below consensus, was “still consistent with the general view that the economy has stabilized,” Capital Economics’ Wang said, but added that there were “no signs that the economy has rebounded strongly.”
Among the bright spots, investment by the state sector and in infrastructure has continued to recover, particularly investment in railways, which fell significantly last summer, Wang pointed out.
“It suggests that the policy stimulus has started to take effect in parts of the economy,“ he said, adding that local governments have also released various stimulus packages over the past weeks, with measures such as consumption subsidies and investment in infrastructure.
All eyes will now be on the bank lending data, due to be released sometime next week, to see whether the performances in May and June can be repeated.
“We think lending data will continue to be strong. One reason is that the PBOC has cut interest rates twice over the last few months and that helped to reduce borrowing costs and also the government has encouraged the investment in infrastructure, and that will be speeding up investment in infrastructure,” Wang said.