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Inflation drops in China

China's consumer inflation last month hovered at lows not seen for 19 months, removing most of the incentive for the government to raise interest rates, official data showed yesterday.

The consumer price index (CPI) rose 1.8 percent last month, extending into a second month a drop in the inflation rate to a level last experienced in October 2003, the National Bureau of Statistics said.

"Given that the rate is below 2 percent, it would be hard for policymakers to make a case for a rate hike," said Yiping Huang, a Hong Kong-based economist with Citigroup.

"Usually, a rate closer to 5 percent would give them a stronger case," he said.

In the first five months of the year, consumer prices increased 2.4 percent year-on-year, compared with a 3.3 percent rise in the first five months of last year, according to the statistics bureau.

Price movements are being watched just as carefully in China as elsewhere -- perhaps even more so because of the political implications. Runaway inflation helped bring down a Nationalist regime in the late 1940s.

Since China hiked local currency lending rates for the first time in nearly a decade late last year, the markets have awakened to the fact that it is now again officially part of the central bank's policy toolbox.

But central bank chief Zhou Xiaochuan (周小川) said earlier this month that interest rates would stay the same at least over the near term.

Andy Xie (謝國忠), a Hong Kong-based economist with Morgan Stanley, said that China may in fact be the country in the region "most vulnerable to cyclical deflation."

This refers to the threat of falling prices, which can discourage consumers from buying goods in the belief future prices will be lower still.

"It faces overcapacity in manufacturing, infrastructure and property in addition to the risk of declining property prices," he said.

Other analysts pointed to a current odd situation where prices of manufactured goods are going down because of over-capacity, while prices of labor and materials are going up.

The statistics bureau confirmed this trend last week reporting producer, or factory gate prices, recorded a 5.9 percent rise last month for the highest rate since December.

The rising producer price index (PPI), boosted by more expensive energy and raw materials, will eventually spill over into higher consumer prices, according to some analysts.

"We believe that the rise in PPI highlights that inflationary pressures have not been fully contained although year-on-year CPI has been low," Goldman Sachs said.

The investment bank said it expected the rising PPI to eventually lead to slight increases in CPI in the second half of the year amid rising wages and employment.

Even as the central bank governor played down the prospect of higher rates recently, he warned about over-optimism on the inflation rate.

"The inflation growth rate is good but don't be too optimistic. We still need to be careful," Zhou said.

Consumer prices in Chinese cities rose 1.4 percent on an annual basis last month while in rural areas they were up 2.4 percent.

The higher inflation in the countryside is in line with government policies to boost incomes in rural areas in order to allow farmers to spend more on consumption.

Food items, which make up a relatively large proportion of the typical Chinese consumer basket, recorded a 2.8 percent rise last month from a year earlier. Non-food prices increased 1.2 percent.
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