June 10 (Bloomberg) -- China’s consumer prices fell for a fourth month, making it easier for the government to keep interest rates low and boost spending to revive the world’s third-largest economy.

Prices dropped 1.4 percent in May from a year earlier, after falling 1.5 percent in April, the statistics bureau said today. The median estimate in a Bloomberg News survey of 16 economists was for a 1.3 percent decline. Producer prices fell 7.2 percent, the most on record.

Inflation may return as the economy recovers and commodity prices climb from last year’s lows. The central bank triggered an explosion in credit this year by scrapping restrictions on growth in new loans and keeping the one-year lending rate at a four-year low of 5.31 percent.

“China’s economy is already rebounding and as soon as it regains momentum, prices will return to positive territory,” said Sherman Chan, an economist with Moody’s Economy.com in Sydney.

The Shanghai Composite Index of stocks rose 0.5 percent as of the 11:30 a.m. local time break in trading. The yuan traded at 6.8330 against the dollar at 12:05 p.m., from 6.8333 before the data was released. Yuan forwards rose on speculation that currency gains will resume as the economy recovers.

Declines in prices in China span consumer goods, food and housing. Producer prices are constrained by industrial overcapacity, the statistics bureau said in a statement.

Deflation Threat ‘Receding’

While falling prices may help the economy by lowering costs for businesses and encouraging consumers to spend, entrenched deflation can choke off demand, as people delay purchases, hoping for better deals in the future.

Energy-price increases may help to end deflation by year’s end, said economist Chan. The National Development and Reform Commission announced on May 31 increases of as much as 8 percent in gasoline and diesel prices after crude oil costs climbed.

Concerns that deflation may be a threat “are receding as global commodity prices rise and economic indicators generally point to improving fundamentals,” said Jing Ulrich, Hong Kong- based chairwoman of China equities at JPMorgan Chase & Co.

While food fell 0.6 percent from a year earlier as pork plummeted 32 percent, the government is concerned about rising grain prices, the statistics bureau said. Grain climbed 5 percent from a year earlier and has gained month-on-month since January.

Home prices fell 0.6 percent in May from a year earlier, the government said in a separate report today.

Inflation Risk

Consumer prices are falling in countries including the U.S., Japan, Spain, Singapore and Thailand. In Japan, producer prices fell in May by the most since 1987, the government said today, adding to signs that deflation may take root.

China should prepare for the risk that inflation may bounce back faster than economic growth, researchers from the State Information Center wrote in a report in the official China Securities Journal today. The central bank should adjust monetary policy if inflation rises above 3 percent and economic growth remains below 9 percent, they said.

The researchers forecast a return to inflation in the third quarter.

While the Reuters/Jefferies CRB Index of 19 raw materials, including oil and copper, is down about 39 percent from a year ago, it has climbed about 14 percent in 2009.

“I think that we may have seen the bottom of China’s inflation cycle,” said Tao Dong, Hong Kong-based chief Asia economist at Credit Suisse Group AG. “A year from now, people will be worried about inflation instead of deflation.”

To contact the reporter on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net

Last Updated: June 10, 2009 00:06 EDT