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Chinese Monetary Tightening Not that Close

The Chinese economy's surprisingly strong 11.9 percent growth reinforces the belief that tighter monetary policy is on its way for the world’s most populous nation. But inflation eased a little bit so tightening may be a way off.

In the absence of any “dramatic fall in external demand, it is critical for the government to tighten policy more decisively than they have been doing in order to prevent overheating,” Goldman Sachs said in a note to clients.

On Wednesday the state council, China’s Cabinet, hinted that it may be ready to act by dropping a reference to the economy not yet being on a solid footing when reiterating it would stick to "appropriately loose" monetary and fiscal policies.

Growth of 11.9 percent was far stronger than the 10 percent expected by the market. Break that number down and you see an impressive 18 percent jump in retail sales and an 18.1 percent jump in industrial policy.

First quarter spending on infrastructure like roads and new factories rose by a stronger-than-forecast 26.4 percent.

All very impressive, but the more important number in the first quarter may be the weaker-than-forecast CPI data.

A 2.4 percent rise was below the 2.6 percent the market had been expecting and some analysts believe this will allow China to tighten policy gradually without having to do so more aggressively and risk over playing its hand.

Thanos Papasavvas, the Head of Currency Management at Investec Asset Management told Squawk Box Europe that despite the big headline data, the level of growth has decelerated a little and should allow Chinese authorities to put the brakes on via tighter lending quotas but not crucially higher interest rates.

This view was mirrored by UBS which told clients that “the stronger-than-expected first quarter GDP growth appears to be boosted by growth outside industrial production, such as consumer-related sectors."

"The data doesn't mean the government will change policies much. At the most, Beijing's concerns for weak economic growth may be lessened,” UBS said.

No Impact on the Yuan

Papasavvas says data will have no immediate impact on the yuan. He predicts that there will be no move to allow the Chinese currency to rise against a basket of currencies until the second or more probably the third quarter.

“It would be unlikely the Chinese would move so close to the meeting with Obama in Washington this week. What today’s data does is allow the Chinese to begin the process of Yuan appreciation without loosing face,” he said.

Papasavvas says any move will be gradual and similar to what we saw in 2008 and suggests investors wanting to profit from the trend should buy into currencies in the region like the Malaysian Ringgit and the Singapore dollar.

Rio Tinto , the global mining giant, is among the first companies to benefit from the strong Chinese data.

The miner is raising its production targets for iron ore after soaring demand from China saw it post a 39 percent jump in output in the first quarter.

The UK-listed miner, which has been locked in a dangerous dance with the Chinese authorities after the arrest of 4 of its staff on charges of taking bribes during discussions over iron ore prices now predicts it will produce 234 million tonnes of iron ore in 2010.

In a statement, Rio CEO Tom Albanese said operations across the world are running at capacity. “Chinese demand grew strongly and we saw some recovery in OECD markets.” Albanese, though, noted the risk of short term volatility remains.

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