Chinese Inflation Index Hits 27-Month High as Food Costs Soar

Surging food prices boosted China's annual consumer price inflation to a 27-month high of 3.4% in May from 3.0% in April, the National Bureau of Statistics said on Tuesday.

Non-food inflation remained subdued, with prices up just 1.0% from a year earlier, but economists said the figures reinforced the case for higher interest rates to prevent banks' effective deposit rates from slipping further into negative territory.

"We expect tighter monetary policy in the coming months given heightened inflation risks and negative real interest rates," economists at Goldman Sachs said in a note to clients.

The overall figure was in line with the median forecast of a Reuters poll of economists, but Shanghai's benchmark stock market index fell 1.5% by late morning as investors started to price in expectations for a tighter monetary policy.

Food prices, which make up a third of the consumer basket, rose 8.3% in May from a year earlier; meat prices rose 26.5%.

Pork prices soared last month as a result of a widespread pig disease and a spike in the price of feed corn, prompting Premier Wen Jiabao to show his concern by making a high-profile visit to a pork market in northwestern China.

Central bank governor Zhou Xiaochuan, who is aiming to keep inflation below 3% in 2007, had said he wanted to see May's CPI to help him decide whether to raise interest rates for the third time this year.

"We know that the authorities will react even to supply shock inflation ... if inflation remains above their line in the sand for too long," said Tim Condon with ING Financial in Singapore. "They said 3% is their line in the sand, so another couple of months like this and I expect we will see rate hikes."

Savers earn 3.06% on 12-month certificates of deposit, meaning that after a 20% tax is deducted, the value of their money is failing to keep pace with inflation.

This has encouraged millions of Chinese to cash in their deposits and punt on the stock market, which jangled government nerves by falling sharply last month after almost quadrupling in two years.

"It's inevitable that the central bank will raise interest rates further. The real rate in China is negative by about 1 percentage point, so I think the current benchmark needs to go up by at least that much," said Yi Xianrong, an economist with the Chinese Academy of Social Sciences, the government's premier think-tank.