Inflation at the consumer level in China fell to a 30-month low in January, giving the central bank plenty of room to cut interest rates further to support the economy and stave off the threat of deflation. Annual consumer price inflation slowed to 1.0 percent last month from 1.2 percent in December, close to market expectations of a 0.9 percent increase.
Consumer inflation would likely have turned negative already but for a spike in food prices because of the Chinese New Year in late January. Non-food CPI dropped 0.6 percent from a year earlier. Many analysts expect the overall price level to drop this month. The National Bureau of Statistics, which released the figures on Tuesday, also said producer prices fell 3.3 percent in the year to January.
The decline, the biggest since 2002, was steeper than the 1.1 percent fall in the year to December and the 2.6 percent drop forecast by economists. Yiping Huang, chief Asia economist at Citigroup in Hong Kong, said the figures pointed to a growing risk of a period of outright price falls.
"In terms of monetary policy, the deflation risk certainly creates huge room for monetary policy expansion, if the policymakers think that is necessary to support growth and possibly also to prevent a further deepening of deflation," he said. The People's Bank of China has already cut interest rates five times since September, and Huang said he thought the central bank could lower the one-year borrowing rate, now at 5.31 percent, to about 4 percent by the middle of the year.
Financial markets' response to the data was muted. The Shanghai Composite Index ended the day up 1.8 percent as new money continued to enter the market on hopes for an economic recovery. The world's third-largest economy is reeling from a slump in trade induced by the global credit crisis, and data due on Wednesday will show that exports and imports fell from year-earlier levels in January for a third month in a row, state media reported.
It was the ninth consecutive monthly drop in consumer inflation, which is now well below the 12-year high of 8.7 percent scaled last February. But economists expressed confidence that China would escape a lengthy bout of deflation, which harms companies by increasing the real value of their debt and robbing them of pricing power.
Expectations that prices will fall further in future can also prompt consumers and companies to put off spending, impeding economic recovery. Tim Condon, head of Asia research at ING in Singapore, said consumer prices could fall by more than 2 percent in coming months, while factory-gate prices could drop by more than 5 percent.
But he joined the chorus of analysts who expect that aggressive actions by the central bank will banish the spectre of a protracted drop in the price level. "Significant monetary easing is the way that you address this, and they've done that," Condon said. "It won't take long for that kind of monetary accommodation to reverse the deflation pressure."
Credit growth is rising fast. An industry source told Reuters on Monday that banks extended about 1.6 trillion yuan in new loans last month, a record. The statistics office sounded relaxed about the plunge in producer prices, which it attributed to drooping global commodity prices and a high statistical base of comparison a year ago, when sky-high pork prices were fuelling inflation. "China has not run into a serious deflationary problem yet, so there is no strong need to cut interest rates now," said Wang Jianhui, an economist at Southwest Securities.
But Frank Gong, chief China economist of J.P. Morgan, said the government could not afford complacency, and ought to stimulate consumption and property demand to ensure that the economy does not backslide into falling prices. "The risk is really deflation. If you do have deflation expectations develop, then one of the key drivers of a bounce in the economy, restocking, may not happen," he said.
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