China may keep tightening policy to fight inflation

Updated: 2008-02-19 15:44

Continued inflationary pressure will encourage China to maintain a program of policy tightening in spite of a likely US-led global economic slowdown this year, analysts said.

They said Chinese policymakers will actually tighten monetary policy further and allow the yuan to appreciate more quickly to help fight inflation after the consumer price index (CPI) for January rose 7.1 percent year-on-year, the highest level in over 11 years.

Related readings:

 China's CPI hits new high of 7.1%
 Producer price index hits three-year high
 Record-high loan growth tests monetary policy
 China works to curb 'structural price rise'
Most analysts had expected the National Bureau of Statistics (NBS) to announce an increase of 7 to 7.5 percent after severe snowstorms caused transport bottlenecks and food shortages across much of the country from the middle of last month.

"Until food supplies return to normal and the threat of inflation is diminished, China is unlikely to ease its current tight monetary bias, as some observers had hoped in the light of the economic problems of its leading trading partners," said Jing Ulrich, chairman of China Equities with JPMorgan.

Goldman Sachs said inflation is likely to worsen in February.

"The inflation impact from the snowstorm may have not been fully reflected in the January inflation data ... the February CPI reading, which is scheduled to be released on March 11, is likely to be much higher than seven percent, and might even get close to double-digit levels," it said.

Food, which makes up about one-third of the CPI basket, was the main driver of inflation, but analysts noted that there is a risk of price pressure spreading to other areas.

Food prices surged 18.2 percent year-on-year in January, while non-food price inflation was 1.5 percent.

Producer price index inflation also accelerated in January, rising 6.1 percent year-on-year, according to an announcement by the NBS yesterday.

To combat inflation, China has allowed the yuan to appreciate more rapidly in recent months. In January, the yuan rose 1.6 percent against the dollar, the fastest pace since it was depegged from the US currency in July 2005, Shen said.

JPMorgan's Ulrich noted that China's monetary tightening program has been complicated by the prospect of a US-led global economic slowdown and recent aggressive interest rate cuts by the Fed.

"While China must maintain a tightening bias until it sees concrete evidence of price declines, administrators are also well aware of rising external risks," Ulrich said.

"China will likely be prepared to switch course to a stimulative policy if the external downturn takes a greater-than-expected toll on China's growth. In this sense, we can think of 2008 as a 'tale of two halves': the first half's tightening policy could give way to easing in the second half," she said.

Moody's analysts Daniel Melser and Ruth Stroppiana added that the US-led slowdown places Chinese policymakers in a quandary.

"Do they continue to tighten policy and try to kill off inflation or instead pause, or even loosen policy, to address the slowdown in the real economy?" they said.

They added that rapid money growth is the root cause of the upturn in inflation.

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