Will Accelerating Inflation End China Stock Rally?

China's stock market rally could be threatened by a higher than expected inflation reading for January and the fact that the central bank has so far failed to cut bank reserve ratios this year, according to one strategist.

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"We were expecting the reserve ratios to be cut over Chinese New Year, they have not been. So I think this [rising inflation] is a bit of a threat to the Chinese equity rally that we've been seeing year to date," Adrian Mowat, chief Asian & emerging markets equity strategist at JP Morgan Securities told CNBC on Thursday.

China's mainland index, the Shanghai Composite

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[.SSEC  Loading...      ()   ], has rallied 6.8 percent year-to-date, while the Hang Seng Index

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[.HSI  Loading...      ()   ] has risen 13.7 percent over the same period, on hopes the central would ease monetary policy this year as inflation eased.

But January's inflation rate of 4.5 percent, surprised economists, who had forecast a rise of just 4.1 percent. It also ended a five-month trend of easing price pressures.

Some analysts, however, are dismissing January's inflation data, which was driven by a big jump in food prices, as a seasonal event tied to the Chinese New Year. Alistair Thornton, China economist at consulting firm IHS Global Insight, told CNBC, he doesn't see Thursday's data release as a "game changer."

"This year, the Chinese New Year was about the earliest we've seen in five years, so that tends to bring forward a lot of the food purchases in particular," Thornton said. "So it wouldn't be surprising if we saw a bit of a kick in food prices, which could buoy headline inflation."

Risks of 'Hard Landing'

JPMorgan's Mowat says the bigger risk for China is a hard landing caused by a slowdown in fixed asset investments rather than accelerating inflation.

"I think there's already evidence that China is having a hard landing in terms of fixed asset investment, construction activity," he said.

"If look at cement production in the final quarter of last year, it was down 9 percent in the third quarter. Residential construction starts in December was down 42 percent on a seasonally adjusted basis, steel production was running at a run rate of about 600 million tons rather than a peak run rate of around 750 million tons."

To head off a major slowdown, Mowat says policymakers will need to enforce much more aggressive monetary easing, rather than the gentle steps taken since late last year.

"Only way they can ease is through cutting the reserve requirements, because remember the reserve requirements are holding 20 percent of deposits within the central banks."

But a report released by HSBC on Thursday said the stronger than expected inflation reading will likely further slow the pace of monetary easing by authorities.

"The resumption of PBoC's repo issuance this week implies the next reserve ratio cut is not coming as quickly as we originally expected," the report said.