China Inflation Accelerates - Time to Remove the Punch Bowl?
With price pressures building at a faster-than-expected rate and exports staging a revival in China, is it time for policymakers to take away the stimulus punch bowl in the world's second largest economy?
The consumer price index (CPI) rose to a 7-month high of 2.5 percent in December, from a year earlier, driven by an upswing in food prices, and the decline in producer prices eased to 1.9 percent from 2 percent in the previous month. In addition, trade data released on Thursday showed mainland exports rebounded sharply in December to 14.1 percent, helped by a revival in Western demand.
(Read More: China December Inflation Accelerates on Food Prices)
As the health of China's economy – which is expected to have grown around 7.8 percent in the fourth quarter – shows rapid signs of improvement, raising the risk of higher inflation, economists say Beijing could pull back on boosting the economy.
In 2012, the government launched fiscal stimulus measures including a $150 billion-plus infrastructure spending package and incentives for exporters. Also last year, the country's central bank cut interest rates and the reserve requirement ratio (RRR) for banks twice each.
Monetary Tightening in the Offing?
But now some economists suggest that the People's Bank of China may go ahead and lift interest rates in the second half of 2013.
"Rebounding price pressures mean tighter monetary policy ahead: stronger currency to curb imported inflation, tighter liquidity and rate hikes in the second-half," Dariusz Kowalczyk, senior economist, Asia ex-Japan at Credit Agricole, wrote in a note.
A further rise in food prices, firmer domestic demand and an unfavorable base effect will push inflation to 4 percent in the second-half, said Kowalczyk, above the government's target of around 3.5 percent.
"(But) the current inflation levels are low enough to ensure that the tightening of monetary stance will be gradual," he added.
Haibin Zhu, chief China economist at JPMorgan, who has currently penciled in a hike in interest rates in the first quarter of next year, said there is risk it could move forward to the fourth quarter of 2013. He too agrees CPI will climb above 3.5 percent towards the end of the year.
Zhu noted that the government's reforms to make prices of resources – including electricity, natural gas and water– more reflective of market demand, will also fuel price pressures this year.
This sentiment, however, is not shared by all. Donna Kwok, economist, Greater China Economics Research at HSBC, believes the upcoming revival of price pressures should remain contained, pointing to producer prices – which didn't pick up as fast as expected in December.
"This leaves sufficient room for Beijing to keep rates on hold for the next 12 months," Kwok said, adding that she expects the central bank to reduce the RRR by 50 basis points twice this year.
Alistair Thornton, senior China economist at IHS, agrees that the pick up in price pressures is not a cause for concern.
Inflationary pressures are inevitable given there has been a genuine pick-up in economic activity over the last few months, he said, adding that this is a "fairly healthy development".
"This points to the start of a benign trend in the economy with the turn of the inventory cycle helped by government stimulus," Thornton said. "There is little pressure from inflation to move on monetary policy."
However, one factor that could trigger a tightening of monetary policy in the latter part of the year, he said, is if property prices "continue unconstrained."
"The likelihood for an interest rate increase towards the back of the year will certainly rise, although authorities have demonstrated a clear preference for administrative measures," he said.
Average home prices in China's 10 biggest cities, including Beijing and Shanghai, rose 0.5 percent in December, from the previous month, and were up 1.1 percent from a year ago - marking the second year-on-year increase in 2012.
By CNBC's Ansuya Harjani