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China July inflation cools; in line with expectations but still below official target

When will China's PPI turn positive?

Consumer inflation in China continued to ease in July, while a softer decline in producer prices fueled expectations that overcapacity in the economy was ebbing.

Producer prices fell 1.7 percent from a year ago in July, better than analysts' expectations for a 2.0 percent decline, Reuters reported Tuesday, citing data from the National Bureau of Statistics. The Producer Price Index (PPI) had tumbled 2.6 percent on-year in June.

July's reading was the slowest decline in producer prices in two years and if sustained, could offer some solace to the country's manufacturers that have endured factory gate deflation for over four years.

Describing the July PPI reading as a "big, positive surprise", Macquarie's head of China strategy Erwin Sanft, said he expected the PPI to finally start turning positive in December after three years in the negative territory.

"Across the coal and steel sectors, there is some capacity elimination happening. We've had three years of really slow investment, particularly among heavy industries, (so) even though there's overcapacity there, it hasn't been getting worse, so that's helpful," Sanft told CNBC's "Squawk Box Asia".

"Generally, everyone is happy in the market. After that credit binge in the first quarter, they actually reigned things in. There's not an attempt to boost growth back to an artificial level," he added.

China's excess capacity still a problem: UBS

ANZ however said overcapacity in the heavy industries was likely to continue weighing on the PPI in the medium term, economists David Qu and Louis Lam wrote in a note.

"Until the capacity reduction has made significant progress, the PPI should not stay strong," ANZ added.

In particular, the beneficiaries of the PPI improvement were likely to be state-owned enterprises involved in the heavy industries, not companies in the private sector, added ANZ.

UBS' China economist Donna Kwok concurred, telling CNBC's "Street Signs" private and manufacturing fixed asset investments were expected to remain soft, offsetting the strength in public infrastructure investment.

A man shops for apples at a fresh produce market in Shanghai in July.
Qilai Shen| Bloomberg | Getty Images

Meanwhile, China's consumer inflation rose 1.8 percent from a year ago, in line with market expectations and compared with a reading of 1.9 percent in June.

Consumer inflation has remained low compared with the official target of around 3 percent for this year, indicating persistently weak demand in the world's second-largest economy.

Still, the People's Bank of China (PBOC) was unlikely to cut benchmark interest rates as consumer prices stabilize and producer prices start improving, the ANZ economists said.

"We do not think the PBOC will need to cut benchmark interest rates as the floor for lending rates and the cap on deposit rates have been removed," the ANZ economists added.

Reuters contributed to this article.

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