China inflation cools, tightening seen on hold

By Kevin Yao and Zhou Xin

BEIJING (Reuters) - China's inflation pulled back in August from a three-year high, underlining expectations that price pressures have peaked and the central bank can hold off on further tightening of monetary policy in the face of a global economic slowdown.

Still, the central bank is far from easing policy. Analysts said inflation, which fell to 6.2 percent in August from 6.5 percent in July, will remain elevated for several months and well above the government's target of 4 percent.

In addition, policy easing could encourage investment away from bank deposits, which are much lower than inflation, feeding Beijing's fears of asset bubbles that could destabilize the economy.

"Consumer inflation has obviously peaked. Inflation is no longer a big problem now," said Dong Xian'an, an economist at Peking First Advisory in Beijing.

"On the policy front, tightening steps are at least on hold now. We've seen some structural easing. In the medium term, China should speed up fiscal reforms."

The pull back in inflation eased investors concerns over price pressures in the world's second-biggest economy, prompting Asian stocks to edge higher.

August's consumer inflation of 6.2 percent was in line with forecasts of economists, who argue that inflation has or is peaking.

Producer price inflation slowed to 7.3 percent in August from 7.5 percent in July, the National Bureau of Statistics said on Friday.

The government is due to release other data later on Friday, including on industrial output, fixed-asset investment and retail sales.

Premier Wen Jiabao and other leaders have repeatedly stressed that wrestling inflation remains the top policy priority despite signs that economic growth is slowing down.

That position was reiterated shortly after the inflation data by Li Daokui, an adviser at the central bank, who said the authority needed to maintain its "prudent" monetary policy.

But policymakers are treading cautiously for fear of slamming the brakes on economic growth, analysts say.

After economic growth of 10.4 percent for all of 2010, the rate of expansion eased back to 9.5 percent in the second quarter.

Some government economists have forecast a further slowdown in 2012 to below 9 percent, arguing Europe's debt crisis and weakening demand growth in the United States will weigh on China's exports.

The People's Bank of China has raised interest rates five times and lifted banks' reserve requirement ratios (RRR) nine times since October.

The policy steps have cooled credit growth, the root cause of price rises, but have also saddled many smaller and medium-sized companies with higher costs that have eroded already-thin profit margins, forcing them to close or cut production.

Food prices, which jumped 13.4 percent in August from a year earlier, contributed 4 percentage points to August's inflation level.

Non-food inflation in August rose to 3.0 percent from 2.9 percent in July.

"My first take is that the easing in consumer inflation was not broad-based in August. The main contribution is a moderation in pork price rises," said Ren Xianfang, an economist at IHS Global Insight in Beijing.

"So China still faces pretty high inflationary pressures."

The consumer price index rose 0.3 percent in August from the previous month, after a 0.5 percent rise in July. The figure is not seasonally adjusted.

NO POLICY EASING FOR NOW

Ting Lu, an economist at Bank of America-Merrill Lynch, said the economic woes of the United States and Europe, plus a belief China inflation is peaking, are putting the focus on a relaxation of monetary policy in China.

"However, we think it's too early to call for monetary easing, such as a system-wide RRR cut, rate cut or a bigger loan quota, because Beijing got big lessons from the extremely loose monetary policies in 2009-2010," he said in a note to clients.

Price pressures are widely expected to cool gradually toward the end of 2011 as economic growth slows, but not fast enough to meet the government's full-year inflation target of 4 percent.

Prices of pork in China, a major factor behind inflation pressures, will continue to rise through the end of the year as supplies remain tight and feed costs increase, a senior industry official said on Thursday.

Indeed, a minority of analysts expect the central bank to raise interest rates once more before the end of 2011.

One argument in support of another rate rise is that returns on bank deposits are too low. One-year bank deposits pay 3.5 percent, so real rates are deeply negative. Many Chinese already channel their savings into property and high-yielding investments.

"It is necessary for the central bank to raise the policy rate gradually to narrow negative real interest rates," Li-Gang Liu, China economist at ANZ in Hong Kong, said in a note.

(Additional reporting by Li Ran, Langi Chiang and Koh Gui Qing; Editing by Ken Wills)