• Inflation prints above forecast. China’s annual inflation rate held steady in February at 4.9 per cent, but was above expectations centred on a result near 4.8 per cent.
• Most prices higher. Most categories recorded higher prices in February with food prices up 11 per cent on a year ago and non-food prices up 2.3 per cent.
• Business inflation (producer prices) remained high at 7.2 per cent in February – a 29 month high.
• Chinese authorities seem to be having a degree of success in paring back activity. Annual growth rates for industrial production and investment were slightly above market expectations but the latest data on retail sales fell well below expectations.
• China’s central bank has also highlighted the inflationary threat, saying that it will stick to a “prudent” monetary policy and that price stability will become more of a priority.

What does it all mean?

• China’s inflation rate remained uncomfortably high in February. But there are signs that the more restrictive policy measures are cooling activity levels. The increase in interest rates and tightening of the reserve ratio seems to have had an impact on retail activity levels. Retail sales slowed sharply in the first two months of 2011 with the annualised growth rate falling to the lowest levels in five years. The timing of the Chinese Lunar New year has certainly skewed the data and as the next couple of months figures will provide a more rounded view of what exactly is taking place in the Chinese economy.
• Despite the volatility of the data given the one-week holiday, inflation clearly remains the major issue. The annual inflation rate printed above forecasts in February, it was still up a solid 1.2 per cent on the month. In addition producer prices also rose over the month and the year, keeping inflation prominently in the centre of the radar screen.
• There is no doubt that higher food prices have been the major driver behind the lift in inflation, with food inflation surging by 11 per cent over the year. Certainly the risk for the central bank is that higher prices become firmly entrenched and results in a flow on effect through the economy. Chinese authorities have in recent times increased distribution of state food reserve and if supply picks up in the second half of the year, inflationary pressures are likely to ease.

• Overall it does seem that activity levels are being pared back and it was even more encouraging that non-food inflation was relatively benign. In fact non-food prices rose by just 0.1 per cent in the month with the annualised rate falling from 2.6 per cent to 2.3 per cent. More importantly it is looking likely that the recent rate hikes will continue to have a dampening effect on activity levels in the near term.
• Going forward, China’s policymakers will remain vigilant against the inflationary threat and if necessary will continue to tighten policy. And while equity markets may react adversely to a slowdown in activity levels it will lead to a more sustainable growth story in the longer term. Keep in mind that if the economy slows too quickly authorities have ample tools available to turn on the stimulus tap.
• China is both Australia’s largest trading partner and top export destination, so solid, sustainable growth is very much in our interests. If the latest rate hike is unable to curb the rapid pace of bank lending further policy tightening may be on the agenda. And while equity markets are likely to react in a knee jerk fashion, the longerterm outlook looks a lot more favourable for Australian mining and energy stocks.

What do the figures show?

• The annual rate of consumer price inflation remained steady at 4.9 per cent in February. The February resultwas above forecasts centered on a result near 4.8 per cent. Inflation in the cities grew at a 4.8 per cent annual  rate, while inflation in rural centers’ grew at a 5.5 per cent rate.
• Food prices rose by 11.0 per cent over the year (10.3 per cent in January) while non-food prices rose by just 2.3 per cent (2.6 per cent in January). Non-food prices rose by just 0.1 per cent in the month, while food prices gained by 3.7 per cent. Fresh vegetable prices rose by 15.2 per cent in the month.
• Producer prices (business inflation) rose by 0.8 per cent in February to stand 7.2 per cent higher than a year ago. The annual rate of producer price inflation was a 29-month high, up from 6.6 per cent in January and higher than economist forecasts of 6.9 per cent. Prices of raw materials rose by 10.6 per cent, Food prices were up 7.3 per cent, however consumer durables fell by 0.8 per cent.
• Industrial output expanded at a 14.9 per cent annual pace in February, and 14.1 per cent in January /February, ahead of forecasts centred 13.3 per cent. Production is still well off the highs of 20.7 per cent annual growth in January/February 2010.
• China’s urban fixed asset investment, such as spending on roads and power plants, grew at a 24.9 per cent annual pace in January/February, ahead of consensus forecasts (23.3 per cent).
• Retail sales grew at a 11.6 per cent annual rate in February and up 15.8 per cent in January/February. The result was well below forecasts centred on 19.0 per cent.
• Chinese passenger car sales rose by 2.6 per cent to 967,200 in the year to February – the slowest annual growth pace in two years. Authorities have continued to tighten up on the issuance of license-plate registrations to ease congestion and pollution in cities. Total vehicle sales rose by 4.6 per cent to 1.27 million in February compared with a year ago.
• China’s recorded its largest trade deficit in seven year in February. The trade balance fell from a surplus of US$6.45 billion to a deficit of US$7.30 billion and was well short of forecasts centred on a US$4.90 billion surplus. Exports were up 2.4 per cent on a year ago (consensus +27.1 per cent) and imports were up 19.4 per cent (consensus +32.6 per cent). The results may have been affected by the early timing of Chinese New Year compared with a year ago.
• Dow Jones report on Chinese monetary policy: “China’s central bank said Friday it will stick to a ‘prudent’ monetary policy and that the country’s macroeconomic controls will make price stability more of a priority, echoing Beijing’s official line as inflation is increasingly viewed as a threat to economic growth and social stability.

• In a statement ahead of a news conference by People’s Bank of China’s Gov. Zhou Xiaochuan, the central bank said it will strive to keep liquidity in the banking system at a “reasonable” level and continue to use interest rates, banks’ reserve requirements and money market operations to achieve the goal.
• The PBOC said it will adopt a differentiated reserve requirement management mechanism for banks this year to make credit growth stable and appropriate. It also reiterated familiar rhetoric on the yuan policy, saying it will continue to make the exchange rate more flexible but also maintain its basic stability.

What is the importance of the economic data?

• China’s National Bureau of Statistics releases its monthly economic statistics around the middle of each month. Quarterly GDP data is released around the 16th of January, April, July and October. China is Australia’s largest trading partner and changes in the Chinese economic have major implications for the Aussie economy.

What are the implications for interest rates and investors?

• Inflation still remains uncomfortably high in China, meaning that further tightening measures will be required. Aussie investors will need to carefully monitor the situation. The risk is that authorities may need to apply more aggressive tightening – clearly negative for Australia’s resources sector.
• However if China did pick up the pace of monetary tightening, that could actually serve to keep Australia’s Reserve Bank on the policy sidelines for longer. Clearly an exacerbated slowdown of the Chinese economy would be negative for our economy.

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