China inflation dips to keep monetary policy prudent

`BEIJING: China's inflation data on Friday may show price pressures fading at a time when its economy is jumpy from softer demand abroad, giving Beijing room to keep monetary policy on hold for now.

Cooling price pressures would also assure investors already unnerved by Europe's debt crisis that the world's No. 2 economy has scope to slightly relax monetary conditions to support growth if need be.

"We think that consumer price inflation will fade to between 4.5-5 percent by the end of this year," said Mark Williams, an economist at Capital Economics in London.

"Even if price pressures don't ease, the rapid increase in prices towards the end of 2010 should pull down headline inflation in both October and November."

Twenty one economists polled by Reuters showed a median forecast for inflation to ease a touch to 6.1 percent in September from 6.2 percent in August. Factory inflation is also seen cooling to 6.8 percent, from August's 7.3 percent.

But whether Beijing would indeed loosen policy to support the economy is less clear, and much would depend on the outcome to the European crisis.

For China's inflation, while moderating, remains elevated. The consumer price index is still running in sight of three-year highs of 6.5 percent struck in July.

And even if inflation pulls back to around 5 percent by December, it is still a good way above Beijing's 2011 target of 4 percent.

On the other hand, China's economy is far from collapsing. Data showed this week that Chinese exports expanded at their slowest pace in seven months in September, but still at a respectable clip of 17 percent.

"Now is not the time yet to really start a broad-based relaxation (in policy) because inflation is still very high," said Jian Chang, an economist at Barclays in Hong Kong.

"If there is no further worsening in the European debt crisis, Chinese policy will continue to be on hold because inflationary pressures are still high."

A head at one of the braches of China's central bank echoed the view this month, saying that China must keep monetary policy prudent lest inflation rebounds.

However, for the less hawkish in China's policy debate, that price pressures are abating should be enough for Beijing to gently ease policy without cutting interest rates.

Credit controls can be relaxed and banks' reserve requirements can be lowered to encourage lending to cash-starved small- and medium-sized firms.

"Recent concerns about the difficulties faced by firms that have had to turn to unregulated underground banks are the latest sign of strains resulting from China's controls on bank lending," said Williams from Capital Economics.

"Clear evidence in a couple of months' time that inflation has peaked is likely to prompt a loosening of this policy."

To combat inflation, Beijing has raised interest rates three times and banks' reserve requirements six times this year.

Copyright Reuters, 2011