China Room to Ease Seen Fading as Inflation Lull Set to End

A U.S. drought that pushed soybean and corn prices to records is adding to the risk of a rebound in inflation in China, where consumer-price gains were probably close to the slowest in two years in September.

Inflation was 1.9 percent last month, according to the median forecast in a Bloomberg News survey before a report on Oct. 15. Credit Agricole CIB says the rate may approach 4 percent by year-end and Citigroup Inc. estimates a pace of about 3.5 percent.

The prospect of faster price gains in coming months may encourage policy makers to refrain from cutting interest rates for a third time this year, contrasting with reductions in Brazil, South Korea and Australia and adding to the risk economic growth will be the weakest since 1999. Increased grain costs are feeding into pork prices and the government is also battling to prevent a rebound in the housing market.

“Inflation will rise in the fourth quarter as pork and other food prices are expected to climb and housing costs are creeping up,” said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong. “This means there is no room for the central bank to cut interest rates.”

The benchmark one-year lending rate is now 6 percent and the one-year deposit rate stands at 3 percent after reductions in June and July.

Loan Limits

Officials at the nation’s top four lenders have indicated that they are limiting discounts for the best corporate clients to 10 percent on the benchmark lending rate, not the 30 percent allowed by the central bank from July. The officials asked not to be identified as they’re not authorized to speak publicly.

Stocks in China have slumped about 14 percent from this year’s high on March 2 on concern the government isn’t loosening monetary policy or introducing stimulus policies fast enough, as the central bank focuses instead on operations in the money market. The benchmark Shanghai Composite Index rose today on signs of improvement in the U.S. economy, gaining 1 percent as of 9:47 a.m. local time.

The yuan rose beyond 6.28 per dollar for the first time in 19 years yesterday on speculation policy makers will act to revive growth and as the central bank raised the currency’s fixing by the most in seven weeks.

Trade Outlook

Trade figures to be released tomorrow may show some improvement in exports. Overseas shipments probably rose 5.5 percent from a year earlier, according to the median estimate of 35 economists, after a 2.7 percent gain in August. Imports increased 2.4 percent, the survey indicated, after a 2.6 percent drop the previous month.

Industrial output, retail sales, fixed-asset investment and gross domestic product figures are due Oct. 18.

The worst U.S. drought in half a century and dry weather in Europe this year are limiting world corn supplies. In China, officials have sold reserves to limit the effect on costs and monitored prices of cooking oil made from soybeans.

A rebound in inflation would complicate efforts to reverse the nation’s economic slowdown, as the Communist Party prepares for a once-a-decade leadership transition. The People’s Bank of China said last month that it will place a bigger emphasis on price stability in setting monetary policy.

Feed Costs

China futures for soybean-meal, the main protein ingredient used in animal feed, advanced to a record last month and wholesale pork prices climbed for seven straight weeks through the week ended Sept. 23.

“The lagged impact of rising corn and soybean prices will push consumer inflation above 3 percent by the year end,” said Yao Wei, China economist at Societe Generale SA in Hong Kong. “Pork prices may take up the inflation baton in coming months.”

China’s inflation rate in the first eight months of the year was 2.9 percent, National Bureau of Statistics data show. The estimates of 34 economists for September consumer-price gains range from 1.5 percent to 2.2 percent.

In contrast, September’s producer-price index, which measures prices at the factory gate, probably fell 3.5 percent from a year earlier, the seventh straight drop, the median estimate in a Bloomberg survey showed. That data is also due Oct. 15.

China’s economy expanded 7.6 percent in the second quarter from a year earlier, the least in three years, as Premier Wen Jiabao’s campaign to cool prices damped demand and Europe’s debt crisis crimped exports.

Cutting Forecasts

Growth may have slowed to 7.4 percent in the third quarter, according to the median estimate of 23 economists surveyed by Bloomberg News from Sept. 11 to 18.

The International Monetary Fund on Oct. 9 cut its projection for China’s expansion this year to 7.8 percent, which would be the weakest pace in 13 years. Alcoa Inc., the largest U.S. aluminum producer, this week reduced its forecast for global consumption of the metal, citing China as the main driver of the slowdown.

Not all economists see looming inflation pressures as large enough to deter easing. Shen Jianguang, a Hong Kong-based economist for Mizuho Securities Asia Ltd., said that while the price cycle may be near its bottom and a rebound is likely, “the economy is still caught in a downturn.”

— With assistance by Lifei Zheng

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