Friday, February 18, 2011

China Weekly: Inflation Likely to Persist Through H1 2011 Despite Rate Hikes


Plates'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 quicker 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 following half of the
year. Beijing faces a mammoth task in attempting to tamp down
inflationary difficulty 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
following half of the year making an unexpected consequence, 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 material goods, 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 ahead of schedule 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
proclamation released by the central bank said it will bring to
somebody's attention 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
Plates 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 largest problems with hiking rates in Plates
is that it will not have the desired effect since the savings rate in
Plates is already very high and higher interest rates will do modest
to attract fresh liquidity. It is because of this we have seen Plates
bring to somebody's attention the reserve ratio requirement (RRR) rate
for banks several times too in an attempt to drain liquidity from the
economy. The inquiry remains if the PBOC will be able to cool
inflationary pressures without overreating and slowing growth.

Turning to Plates's trade weigh 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, but,
were instant to note 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
proclamation posted on its website that Plates 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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