China Weekly: Inflation Likely to Persist Through H1 2011 Despite Rate Hikes
China’s consumer price index (CPI) rose 4.9% in January from a year earlier according to the National Bureau of Statistics, the figure matched the leaked result from Monday but was below the average consensus of 5.4%. While inflation rose at a slower than expected rate, certainly a ray of light, the producer price index (PPI), measuring wholesale inflation, climbed at a faster than expected rate of 6.6%, forecasts had been for a 6.3% rise. Despite the appearance that inflation is moderating many still tip CPI to reach 6% sometime in the first half of 2011 before cooling in the second half of the year. Beijing faces a mammoth task in attempting to tamp down inflationary pressure in the economy without enacting, what may be perceived to be as, draconian measures, which may also slow growth. Some analysts at RBC suggest that CPI wont soften that much in the second half of the year making an unexpected event, ie weather related crop failures, catastrophic. Brian Jackson, an analyst at RBC, said “the risk is that inflation will stay stronger for longer, particularly if serious drought conditions in the north of the country persist or worsen”.
The National Bureau of Statistics also announced several weighting changes to the way it calculates the consumer price index, increasing the weighting of property, which it said added slightly to the January inflation figure. The bureau said it recalculated the gauge of consumer outlays to reduce the weighting of food to 30.2% from 32.4% previously, while housing was increased to 19.2% from 15%. BofA Merrill Lynch analyst Ting Lu said that CPI may moderate in February though not enough to avoid further interest rate hikes, which could come in April. He said increases in banks’ reserve ratio requirements were possible as early as this month.
In anticipation of a strong CPI reading the PBOC acted ahead of the release and hiked interest rates last week for the third time since October in an effort to cool rising inflation pressures. The statement released by the central bank said it will raise the one-year lending rate to 6.06% from 5.81% while boosting the one-year deposit rate to 3% from 2.75%. As we discussed above interest rate hikes as the expected way by most that China will try and damp down inflation in coming months and this most recent hike was largely expected by the market, although some felt the timing was somewhat of a surprise. We have mentioned several times in the past that one of the biggest problems with hiking rates in China is that it will not have the desired effect since the savings rate in China is already very high and higher interest rates will do little to attract fresh liquidity. It is because of this we have seen China raise the reserve ratio requirement (RRR) rate for banks several times too in an attempt to drain liquidity from the economy. The question remains if the PBOC will be able to cool inflationary pressures without overreating and slowing growth.
Turning to China’s trade balance data which was also released last week, imports surged from a year earlier while exports grew at a slightly slower rate, slashing the monthly trade surplus in half to $6.5 billion, the lowest reading in nine months. Many analysts, however, were quick to comment that the numbers were heavily distorted by a flurry of trading activity being pushed through ahead of the week-long Chinese New Year holiday, which fell a week earlier this year than last year. We won’t be surprised if the trade data for February slumps after exporters and importers front-loaded their trading activities in January.
Finally, the State Administration of Foreign Exchange (SAFE) said in a statement posted on its website that China is not facing losses of up to $450 billion on bonds issued by Fannie Mae and Freddie Mac as was claimed in a recent media report in the daily International Finance News which cited the loss figure. The regulator said it had been receiving interest payments of around 6% annually through 2008 and 2010 on bonds issued by the US mortgage agencies, and that reports it had suffered losses on securities issued by them were “groundless” SAFE added that it had never invested in equity issued by either agency.
Written by Jonathan Granby, DailyFX Research Team
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