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The Silver Lining in China's Dark Clouds? Lower Costs

China’s latest inflation numbers suggest the economy is cooling faster than economists expected, but the drop in producer prices by a steeper-than-expected 2.1 percent in June could provide a boost for corporate margins, according to experts.

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Producer prices declined for the fourth straight month in June and economists tell CNBC that means lower commodities and input costs for manufacturers.

“The real key here is as we see prices come off, particularly producer prices, it does provide some cushion to manufacturing margins,” Ben Simpfendorfer, Managing Director of Silk Road Associates, an economic consultancy firm, told CNBC Asia’s“The Call”. At the same time, consumer inflation cooled to 2.2 percent in June, from 3 percent in May, official data showed on Monday, giving the Chinese central bank more scope to ease monetary policy to support growth without stoking fears of excessive price increases.

“There is a big backstop here, and that is the government. They can cut rates, they can ease credit, they can expand fiscal stimulus, so there is support for the economy over the next six months,” Simpfendorfer said.

In fact, some economists are expecting the consumer price index (CPI) to continue declining in the third quarter from June’s levels, providing more room for policy easing, especially after Beijing’s leaders signaled that they need to be more aggressive to achieve the 7.5 percent target this year for GDP growth.

“We expect CPI to drop further in July to less than 2 percent,” Nomura Chief China Economist Zhiwei Zhang said. “Lower CPI opened room for further policy easing, which we expect will pick up. In particular Premier Wen [Jiabao]’s comments over the weekend point to stronger public investments in coming months.”

Nomura expects inflation to average 2.8 percent, 1.9 percent and 2.9 percent in the second, third and fourth quarters of the year, respectively.

Wen said on Sunday that China needs to make aggressive efforts to fine-tune its economic policies in order to support its economy, suggesting that Beijing will take further action to fight “huge downward pressure.”

His remarks came days after China's central bank slashed interest rates for the second time in a month on Thursday. Economists interpret the surprise cut as a signal that GDPgrowth for the second quarter, to be released on Friday, will be the weaker than expected.

Economists polled by Reuters, say China's economy will grow 7.6 percent in the second quarter from a year ago. That would mark the slowest quarter of expansion since the three months to March 2009, at the depths of the global financial crisis.

Both Simpfendorfer and Zhang think the market is being too negative about China’s economic data.

“We believe investors are becoming too bearish on the outlook for China’s economy in the second half,” Zhang said. “No doubt the economy slowed further in the second quarter, many growth indicators look weak, but there are also positive signs that should not be ignored.”

Nomura is standing by its view that the Chinese economy has bottomed out in the second quarter, and will rebound from 7.8 percent in the second quarter to 8.6 percent in the third quarter and 8.9 percent in the fourth. The bank expects growth of 8.4 percent for the whole of 2012.

- By CNBC's Jean Chua.

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