December 09,2011

CPI and PPI Inflation Fell More than Expected: Will China Stimulate More?

By Lu Ting

In Nov, inflation readings dropped more than expected with CPI inflation down to 4.2% YoY from 5.5% in Oct and PPI inflation further slumping to 2.7% YoY from 5.0% in Oct. In comparison, the market expected CPI at 4.5% and PPI at 3.4%. In Dec, CPI inflation could remain around 4.2%, due to a rising comparison base and falling pork and energy prices, while the power tariff hike should have little impact on CPI in the month.

Market and policy impact

These data could be positive to market sentiment. The larger-than-expected drop in inflation readings could make many people more convinced about a major policy easing in the near term. We think that inflation risks have been greatly allayed which could allow Beijing to be more growth friendly. Beijing has started fine-tuning its policies since early-Oct, and liquidity conditions and credit supply have been significantly improved. The 50bp RRR cut released about RMB350bn money to the banking system; and we expect new loans could remain strong at RMB580bn in Nov and around a similar level in Dec, without breaching the annual quota at RMB7.5tn. Overnight shibor rate fell to 2.86% this week from 4.9% in early Oct, and discount rates of bankers' acceptance slumped to 7.5% this week from 13.0% in early Oct.

CPI inflation could be at 3.5% in 2012

Inflation risks in China have been significantly lowered due to the worsened global economic outlook and the ongoing downturn of the pork price cycle. We expect CPI inflation could average at 3.5% in 2012, with CPI readings possibly at 3% or even lower in some months in mid-year. For PPI inflation, we expect it could fall to 2.0% in 2012 from 6.2% in 2011, as global commodity and raw material prices could be relatively stable in 2012.

Some people project CPI inflation below 3% or even negative in 2012. In our view, the chance for a very low inflation is very small, because China's policies are flexible. If inflation is declining faster than projected, the government will likely seize the opportunity to carry out power tariff hikes and other price reforms, which would be difficult when inflationary pressures are high.

Details: month-on-month and breakdown

In month-on-month terms, food prices declined 0.8% in Nov (vs. the fall of 0.2% in Oct) while non-food prices rose 0.1% in Nov (vs. 0.2% in Oct). As a result, CPI fell 0.2% in Nov (vs. the rise of 0.1% in Oct). PPI declined by another 0.7% in Nov after falling 0.7% in Oct.

On CPI breakdown, food price inflation slowed to 8.8% YoY in Nov from 11.9% in Oct, while non-food inflation fell to 2.2% YoY in Nov from 2.7% in Oct. Pork prices, which was a major inflation driver, rose 26.5% YoY in Nov (contributing 0.78 ppt to CPI inflation), down from 38.9% YoY in Oct (contributing 1.12 ppt to CPI inflation). Note Pork prices have declined about 11.7% from the peak in early September. Housing costs rose 3.0% YoY in Nov, down from 4.4% in Oct.

 

(The author is a China economist with BofA Merrill Lynch)

 

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