Falling prices spur expectations of China rate cut

China’s national ego is swelling once again as patriotic citizens proudly count the gold medals won at the London Olympics. But the national economic data released last week tells a different story.

China’s consumer price index (CPI) for July fell to a two-and-a-half year low of 1.8%, down from 2.2% in June. The figure is falling further from a 4% inflation target the Chinese government has set for 2012, which gave a strong signal that Beijing will come up with more aggressive stimulus measures to revive the world’s second-biggest economy.

“The 30-month low inflation reading reinforces the case for more decisive easing actions soon,” said Qu Hongbin, China economist at HSBC. “We expect another 25bp rate reduction and 100bp worth of reserve ratio cuts within the third quarter. The next rate cut could be delivered in the coming weeks, if not days.”

Food prices, which make up more than a third of China’s inflation basket, rose 2.4% last month, easing further from 3.8% in June, according to the data released by the National Bureau of Statistics on Thursday. The decline in pork prices, a major element of China’s CPI, widened to 18.7% in July from 12.2% in June, which was the biggest drop since August 2009.

Analysts say that the decrease in food prices is mainly because supply is catching up with demand. “Pork inventory is pretty high and demand has been steady, so we see declines in the price index month after month,” said Jean-Yves Chow, a senior industry analyst at Rabobank. “I will not be surprised at all to have a negative food CPI in the next two months. Pork and vegetable prices continue to fall, driving the food CPI below zero.”

China’s July industrial production (IP), an economic indicator tied more closely to the nation’s economy, decelerated to 9.2% from 9.5% in June, well below market expectations.

“July’s growth data suggests that China’s growth slowdown continued into the third quarter, despite signs of stabilising investment thanks to Beijing’s earlier easing measures,” said HSBC’s Qu.

Beijing’s policy report has suggested that monetary policy in the second half of this year should be forward-looking, targeted and efficient, and that appropriate monetary and credit expansion would be crucial to support real economic activity, said Jing Ulrich, head of global markets for China at J.P. Morgan, in a research note.

“We continue to look for further monetary policy in the coming months,” she said. “In particular, we expect one more interest rate cut and two or three RRR [reserve requirement ratio] cuts over the rest of this year.”

Overall activity numbers for July were weaker than expected as industrial growth continued to weaken against an expected rebound. July trade data, also released last week, was similarly lacklustre, with slower growth in both exports and imports.

“Though another Rmb4 trillion is unlikely, most of the local governments are preparing or have already launched a stimulative investment programme, which is set to push up the investment growth in the months ahead,” said Liao Qun, chief economist at Citic Bank International.

China’s economic growth is cooling. Last month, the government said China grew at an annual rate of 7.6% during the second quarter — down from 8.1% the previous quarter.