March 11,2011

China's Feb Inflation Surprises Market, More Tightening?

By Lu Ting,Hong Kong

Jan-Feb Macro economic data were just released. Market could respond negatively on higher-than-expected CPI inflation. Though robust FAI and IP data could alleviate some concerns on the misleading sharp fall of trade growth in Feb, investors might nonetheless be concerned that robust IP/FAI and high inflation could lead to more tightening measures.

 CPI and PPI inflation

 CPI inflation came in at 4.9% YoY in Feb, unchanged from in Jan. Markets have been rumoring about various versions from 3.9% to 4.9% (we expected 4.8%), so this above-consensus reading could be negative to market sentiment. Actually, though we don't think inflation will be out of control in China, it's time to be more cautious because CPI inflation will most likely rebound to around 5.5% YoY in March. The forecasting trick here is actually quite simple. Last year food prices dropped 1.5% MoM from Feb to March, but this year food prices could be at best flattish from Feb to March. Since food accounts for 30% of the CPI basket, you need to add about 50bp to the headline Feb CPI inflation data to get the March reading.

 As expected, PPI inflation accelerated further in Feb to 7.2% YoY in Feb from 6.6% in Jan on surging prices of oil and iron (we expect 7.1%). Iron ore prices were up 6% from Dec and up 63% YoY; Oil prices were up 9% in Dec and 19% YoY. With the chaos in MENA, PPI inflation could rise further on higher oil prices. However, the oil supply shock could also dent prices of other commodities such as iron ore and copper, helping reduce pressures on PPI.

 Data of IP, FAI and retail sales

 The NBS only reports combined Jan-Feb data on IP, FAI and retail sales to avoid unnecessary confusions (individual monthly data in Jan and Feb are greatly distorted by the CNY holiday; you know the case of trade data).

·       IP (industrial production, in real term) growth surprised on the upside to 14.1% YoY in Jan-Feb, up from 13.5% in Dec, suggesting the Chinese economy was growing robustly and Chinese manufacturers are restocking again. Some other data released earlier pointed to this fact. Daily average output of crude steel over Feb 21-28 rose 5.5% to 1.912mn (a record high) from the previous 10 days. Average daily output in Feb was 1.823mn tons, up 7% MoM from Jan.

·       FAI (fixed asset investment, in nominal terms) growth 24.9% YoY in Jan-Feb, up from 23.9% in 4Q10. In real terms, FAI growth could be 17.6%, unchanged from 4Q10. FAI growth could remain stable because: (1) the 10mn social housing program could cost RMB1.4tn, up from RMB400bn last year and contribute 2ppt GDP growth; (2) The government's new found interest in spending on China's outdated water system; (3) Further push on infrastructure such as subway and power grid, and the social housing revolution could also add demand for urban infrastructure.

·       Retail sales (in nominal terms) growth fell sharply to 15.8% YoY in Jan-Feb from 19.1% in Dec 2010. In real terms, retail sales growth could be 11.2% YoY, down from 14.4% in Dec. The major driver of this big slowdown must be auto sales, which accounted for 20% of the headline retail sales. Due to Beijing's new policies on license and its contagion effect, auto sales growth was boosted in Dec but surely slumped after that. Total national auto sales grew 9.9% YoY in Jan-Feb, down from 17.9% in Dec 2010. Passenger car sales grew 10.5%, down from 18.6% in Dec, while truck sales grew 7.8%, down from 15.4% in Dec.

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