China's medium-term inflation outlook

- "Average inflation, as measured by the CPI, has been largely on a downtrend in the past decade till early 2007 (Chart 1). Such a downtrend not only permits the central bank to cut interest rates in times of economic difficulty, but also encourages authorities to keep rates low even when the economy recovers. Real GDP growth is likely to accelerate to 10% YoY this year from 9.1% in 2009. The CPI is likely to rise from -0.7% to a projected rate of 4% (CPI averaged 2.7% in the first seven months of 2010) during the same period. Acceleration of the general price level has been faster than that of the real economy. Yet, the PBoC has chosen to keep lending rates on hold despite the fact that most Asian central banks have hiked interest rates."
- "We reckon that the PBoC's decision to hike rates will depend on the timing of the Fed hikes. The Fed seems unlikely to raise rates until mid-2011 and perhaps not until later. Weak economic data in the US have renewed fears of a double dip recession and mounting speculation over whether Beijing will start loosening (at least pertaining to those measures placed to cool the property market) towards the end of the year. Inflationary pressure, however, has been rising on most fronts, including wages (See China: Rising wage concern and China: Implications of rising wages (Part II)). China will soon have to choose between sustaining high growth at the cost of higher inflation or dampening growth in return for lower inflation."
- "Policymakers might be tempted to let interest rates remain at the current levels. After all, an annual inflation rate of 3% is perfectly acceptable when the real economy is growing at 10%. From a monetarist's perspective, the current inflation level may seem too good to be true. Broad money supply (M2) was advancing at 3.27x of nominal GDP in 2009, compared with an average of 0.91x between 04 and 08. The general price level started responding only one year later."

DBS Economics 20100827

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