Bloomberg News

China Inflation Heading for 6% Shows Danger of Rate Pause

June 15, 2011

(Updates stocks in fifth paragraph.)

June 15 (Bloomberg) -- China’s inflation pressures have yet to be contained by four interest-rate increases since September, underscoring the danger of any extended policy pause as bad weather threatens to further drive up food costs.

The central bank yesterday increased banks’ reserve requirements to drain cash from the economy after consumer prices rose 5.5 percent in May, the biggest gain since 2008. Inflation may reach 6 percent this month, according to banks from Societe Generale SA to UBS AG.

Premier Wen Jiabao’s government has surprised analysts at banks including Barclays Capital by pausing on interest rates for 10 weeks, the longest gap this year. Officials may be reviewing signs of weakening global growth after the U.S. unemployment rate surpassed 9 percent and manufacturing cooled across Asia.

“There’s still a long way to go” to contain prices, Shen Jianguang, chief economist for greater China at Mizuho Securities Asia Ltd. said in a Bloomberg Television interview. “We need to see a slowdown in the economy,” said Shen, who previously worked for International Monetary Fund. He predicts two more rate increases this year.

The Shanghai Composite Index fell 0.9 percent today, the biggest decline in a week, after gaining 1.1 percent yesterday on stronger-than-forecast industrial production data for May. The market was closed when the central bank announced the reserve-ratio increase yesterday.

Rate Forecasts

Nomura Holdings Inc. said yesterday that interest rates may rise this month and again in the third quarter. Barclays sees one more increase this year, either in June or July. The half percentage point boost to banks’ reserve ratios will take effect on June 20.

A favorable so-called base effect may help to limit inflation in the second half of the year.

Still, stocks are unlikely to stage “a sustained rebound until the market sees clear signals that inflation has peaked,” said Hong Kong-based Jing Ulrich, chairman of global markets for China at JPMorgan Chase & Co. “Extreme weather” could delay a moderation in inflation by fueling food-price gains, she said.

A drought along the Yangtze river has been followed by fatal floods. Food costs rose 11.7 percent in May from a year earlier as pork prices climbed.

Global Challenge

Low-income nations from India to Algeria are struggling with food prices that climbed to a record in February according to a United Nations gauge. The Food and Agricultural Organization index was up 37 percent in May from a year earlier.

China has so far boosted interest rates every other month from mid-October, with the most recent increase taking effect on April 6. Officials have also increased banks’ reserve requirements to a record and allowed the yuan to gain about 1.6 percent against the dollar this year.

“I’m reasonably hopeful the Chinese authorities will move to increase rates,” Stephen Roach, non-executive chairman of Morgan Stanley Asia Ltd., said in an interview in Shanghai today with Bloomberg Television. “Historically, inflation has been very destabilizing for China. The authorities know this.”

Signs of Unrest

While the economy’s expansion is showing signs of moderating, inflation has risen further above the government’s 4 percent target. India, Thailand, Singapore and Malaysia also face price pressures even as their industrial output growth slows or falls.

Wen aims to tame prices and sustain growth to maintain social stability, with the premier noting in March that inflation, corruption, and the gap between rich and poor could “affect the government’s hold on power.”

Signs of social unrest have include clashes involving street vendors in Zengcheng, Guangdong, this month and riots last month in Inner Mongolia. The government has also detained activists after calls for so-called “jasmine” rallies, inspired by revolts in the Middle East and North Africa.

The jobs created by economic growth forecast by the World Bank at 9.3 percent this year may help the government to maintain stability.

“The market has been increasingly worried about a hard landing in China, but the latest data show the economy is still going strong,” said Wang Tao, a Beijing-based economist for UBS. “Hard evidence of a soft landing” was the heading on a Nomura report.

Fixed-asset investment excluding rural households expanded 25.8 percent in the first five months of the year, up from 25.4 percent in January-through-April. Retail sales, which are boosted by inflation, rose 16.9 percent after a 17.1 percent gain in April.

--Zheng Lifei, with assistance from John Dawson and Sophie Leung. Editors: Paul Panckhurst, Cherian Thomas.

To contact Bloomberg News staff for this story: Zheng Lifei in Beijing at lzheng32@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at ppanckhurst@bloomberg.net


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