China’s inflation may have dipped to 5.8% in October

As the European debt crisis deepens, the market has started to speculate that an easing trend of headline CPI may lead to an imminent loosening of monetary policy in China. In fact, the CPI and PPI are projected to fall to 5.8% YoY and 5.5% in October, down further from 6.1% and 6.5% in September respectively.

The consolidation in property prices nationwide is also gradually gaining more momentum as property developers cut prices to lure buyers. These results are engineered by the 18-month long tightening program, representing preliminary results only. It is premature to loosen monetary policy on a broad basis at this juncture.

Firstly, there is an enormous pent-up demand in the property market. Relaxation of administrative measures amidst a negative rate environment negates the effort done hitherto. Secondly, the impact of Thailand’s flooding may exert upward pressure on food inflation in the region. Last but not least is the possibility of another QE program in the US some time in 2012. It pays to stand pat on policy for the time being. As such, M2 is projected to grow 13.0% in October, same as September.

In light of slowing external demand, more consolidation in the manufacturing sector is underway. The steep dip in the export orders component of the manufacturing PMI to 48.6 in October from 50.9 in September foretells a similar downtrend in industrial production and exports. As a result, industrial production will likely advance 13.5%, down from 14.2% in September. Exports will further deteriorate to 15.0% in October from 17.1% in Sep. As the fall in import prices may bolster quantity demanded, imports are projected to advance 22.0% in October, up from 20.9% in September, resulting in a trade surplus of US$23.2bn.

As far as domestic demand is concerned, nominal retail sales growth will resiliently advance 17.5% YoY in October, down slightly from 17.7% in September. Urban fixed asset investment will remain as the primary growth driver for some time. It will be difficult for the state to slow down this engine against the global headwinds in the near future. The construction of social housing will keep FAI YTD growth around 24.9%.

The drag on the external front will make further monetary tightening difficult. At the same time, China must stay vigilant against the potential threat of liquidity inflows. Status quo is still a dominant strategy at this juncture.