Why Inflation in China Will Raise Its Head Again

China's October Inflation numbers came in below expectations, proving to be of little concern to the country's policymakers at the moment, but economists warn the inflation rate could double by mid-2013 as growth in the world's second largest economy gains momentum.

Why Inflation in China Will Raise Its Head Again
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The consumer price index (CPI) rose 1.7 percent in October from a year earlier – below forecasts for a rise of 1.9 percent – the lowest reading since February 2010. On a month-on-month basis, CPI declined 0.1 percent – the first fall in four months.

The dip in inflation was driven by food prices, which eased 0.8 percent from September. Non-food prices, however, rose 0.3 percent from the previous month, which is close to the historical average.

"This indicates that there are structural inflationary pressures in the economy, which should drive inflation as growth recovers," Zhiwei Zhang, chief China economist at Nomura, wrote in a note on Friday.

In addition, the slowing pace of decline on the Producer Price Index (PPI) suggests that economic momentum is picking up, he added.

China's PPI fell 2.8 percent year on year in October, compared to a 3.6 percent decline in September. The October PPI numbers are consistent with the recent Purchasing Managers Indices, which showed both input and output price components climbed back above the 50-threshold (which indicates expansion), according to analysts.

Zhang expects inflation to significantly rebound in the first-half of 2013 and monetary policy to shift from easing to tightening. He believes inflation could hit 4 percent by the middle of next year.

Haibin Zhu, chief China economist at JPMorgan agrees that prices pressures are likely to build in the coming months.

"The favorable base effect that has been driving the easing in inflation has disappeared, and food prices may increase again toward the year-end and the Chinese new year (in February)," Zhu said.

While benign inflation creates room for the People's Bank of China to embark on further easing, China, experts believe there is limited scope for additional monetary stimulus this year.

Don't Expect Stimulus

"I don't expect any easing in monetary policy until the end of this year because it would be unnecessary as the economy is recovering," Yao Wei, china economist at Societe General told Reuters.

Other macroeconomic data including industrial production, fixed asset investment and retail sales, due to be released later on Friday, is expected to show the economy is on a path towards recovery.

With low probability of further interest rate cuts this year, Zhu expects the central bank to focus on liquidity management using a combination of reverse repos and a cut to the banks' reverse requirement ratio (RRR). He forecasts the central bank will cut the RRR by 50 basis points by the end of the year.

On the fiscal stimulus side, economists see a near-zero chance of the government rolling out a "big bang" stimulus plan.

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"The policymakers have been doing quite a bit in terms of supporting growth by infrastructure spending, and releasing money to the economy, but they don't like the idea of something that has big headlines like the $4 trillion stimulus," said Louis Kuijs, chief China economist at RBS, referring to the stimulus package unleashed by Beijing in 2009 to deal with the fallout from the global financial crisis.