With Inflation At Four-Year Low, Should China Worry About Deflation?

The author is Liu Li-Gang, chief economist of Greater China at ANZ

China’s consumer price index (CPI) inflation slowed sharply to 1.6% year-on-year in September, the lowest level since January 2010, compared with 2.0% in the prior month.

On a monthly basis, CPI rose 0.5%, lower than 0.8% recorded last September.

The sharp deceleration of CPI inflation is largely due to surprisingly low food prices during the Mid-Autumn Festival and before National Day holidays.

In our view, the anti-graft campaign could have significantly eased upward pressures on prices. Notably, among CPI’s sub-indices, the price of tobacco and liquors has dropped to negative territory since September 2013.

As CPI inflation decelerated faster than expected in the recent month, we lower our CPI forecast for 2014 to 2.0%, from 2.2% to 2.3% previously. The average CPI inflation in the fourth quarter is unlikely to exceed 2.0%.

Producer price index (PPI) inflation fell further to a decline of 1.8% in September, 0.6 percentage point lower than last reading, reflecting a de-stocking process amid sluggish domestic demand.

In addition, it suggests that the profit margin of Chinese corporates will be further squeezed and their capital expenditure demand will remain weak in the next few quarters.

China’s soft inflation profile heightens the risk of deflation, thus requiring further monetary policy easing. Indeed, the People’s Bank of China (PBoC) had taken actions before inflation figures were released, and it lowered the 14-day repo rate by 10 basis points yesterday morning, to 3.4%.

This was the third time that the PBoC reduced 14-day repo rate, suggesting that China’s monetary easing bias remains.

In our view, the PBoC could adjust repo rates more frequently in the future and will experiment the transmission from repo rates to deposit and lending rates of commercial banks.

The PBoC appears to use some innovative policy instruments to implement monetary policy, indicating that China is pushing towards interest rate liberalization.

(The article has been edited for clarity)

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