Chinese inflation falls sharply, time to ease?

China’s October consumer price index fell to 5.5% year-on-year, the lowest during the past five months, leaving room for the government to push on with selective easing policies in the coming months.

The lower CPI number, which compared with 6.5%, 6.2% and 6.1% for July, August and September respectively, shows Beijing’s battle against soaring consumer prices has taken effect. However, inflation remains a top concern for policymakers and a monetary policy U-turn is unlikely before headline CPI drops to below 4%, which is Beijing’s inflation target for 2011, according to HSBC.

“There will be neither further tightening nor an immediate relaxation of the tightening this year,” said Liao Qun, chief economist at Citic Bank International. “The monetary policy will be kept largely stable in the last months of the year, though a selective relaxation to some sectors, including the export industry and small and medium-size enterprises, is likely.”

Qu Hongbin, co-head of Asian economics research at HSBC, says the monetary easing will not only help smaller businesses but also public housing and ongoing infrastructure projects.

Observers expect an overall relaxation in monetary policy to come in the first quarter of next year.

Chinese leaders have reiterated that their top priority is to curb stubborn inflation. They repeatedly told state-owned enterprises not to increase the selling prices of their products, and state-owned banks to reduce their loans and extend restrictions on home purchasing all the way from tier-one to tier-three cities in the country.

China’s central bank has raised interest rates five times since October 2010 to July this year, and lifted banks’ reserve requirements nine times to a record 21.5% for the large lenders.

The current 3.5% one-year savings rate has been lagging behind headline inflation for 20 months. The resulting negative interest rate has encouraged the country’s ardent savers to shift money out of banks and invest in risky informal lending, where interest rates can be as high as 70% a year, according to Tao Dong, a regional economist at Credit Suisse.

A slowdown in food price rises made the biggest contribution to October’s CPI. Food prices rose by 11.9% year-on-year in October as compared to 13.4% in September. Softened housing costs also contributed, which were up 4.4% in October versus 5.1% for September.

Meanwhile, the producer price index (PPI) rose just 5% in October compared to 7.1% in September, which was another contributor to the eased CPI inflation and also indicates a further easing of inflationary pressure in the coming months, said Citic Bank International.

The CPI is expected to ease further to below 5% in the last two months of this year. But for 2011 as a whole, the inflation rate is forecast to be 5.4% or 5.5% year-on-year, noted the bank.

The official People’s Daily newspaper said in a strongly worded editorial that it will be “very difficult” for China to meet its 2011 inflation target.

The National Development and Reform Commission, China’s top planner, has lifted its CPI target for 2011 to 4% after the country failed to meet the 3% target last year, it revised the target to 5% several months ago, but that revised target still looks out of reach.