China's Inflation Higher Than Target Rate, Could Be a Sign It's Time to Tame Rapid Growth

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China's inflation rate rose 3.1% in May from a year earlier, exceeding the government's 3% target rate for 2010 and stirring speculation on whether or not Beijing will attempt to slow the nation's rapid growth pace.

The consumer price index climb was the fastest in 19 months and was higher than the 2.8% rate in April. The National Bureau of Statistics also posted increases in industrial production, retail sales, and property prices, which contributed to analysts wondering whether or not China will make moves to tame growth to avoid higher inflation.

"Officials seem confident that price pressures will ease later this year, attributing much of the recent positive trend to base effects, but there are plenty of reasons to think that inflation can keep moving higher," Royal Bank of Canada (NYSE: RY) economist Brian Jackson told The Wall Street Journal.

The rise comes at a time when Chinese workers are starting to strike for higher wages, which could push inflation even higher.

Three Honda Motor Co., Ltd. (NYSE ADR: HMC) suppliers are dealing with employee strikes and Hon Hai Precision Industry Co. is raising wages after its Foxconn International Holdings Ltd. (PINK ADR: FXCNY) iPhone-making plants have suffered a string of suicides. Companies across several industries could see pay increases from 5% to 27%.

The Australia and New Zealand Banking Group wrote to investors Friday that worker strikes for higher pay "suggest that wage hikes will spread across industrial sectors, placing pressures on firms to raise prices on their final products," and "inflation is far from its peak."

The bank said China needed "to switch its policy priority from controlling credit to raising interest rates in order to counter the risk of run-away inflation."

Some Chinese lawmakers are supporting a rate hike that would give depositors more interest on savings. Savers are getting 2.25% at the benchmark rate, meaning a loss of deposits after inflation is taken into account.

Should China decide to slow its growth it might do so by raising interest rates or appreciating the yuan. Its resistance to adjust the yuan thus far has strained relations with U.S. officials who argue the low value gives a competitive advantage to Chinese trade.

But Chinese authorities have continued to state they think inflation will cool in the second half of the year, citing falling food and commodity prices.

"Global commodities prices have kept falling a lot after the debt crisis broke out in Europe. This helps us to contain inflation pressures," National Bureau of Statistics spokesman Sheng Laiyun said after the numbers were released.

"We don't expect a knee-jerk reaction from policymakers," Bank of America-Merrill Lynch (NYSE: BAC) economist Lu Ting said in a note.

Money Morning Contributing Editor Martin Hutchinson is confident China's inflation has yet to peak and the nation should heed the warning signs.

"If you want to see inflation in action, you can see it most clearly in China," Hutchinson said. "China's inflation statistics understate the truth even more seriously than most emerging-market nations. You can see that the Chinese people think inflation is much higher than that from the wage rises being demanded."

Hutchinson said the wage increases paired with higher real estate prices that are not accurately depicted in the inflation numbers are sure to drive China's inflation rate higher.

"Although China's productivity is rising, it's not doing so quickly enough to absorb wage increases in the 20% to 30% range (let alone in the ultra-high-rent 66% to 75% neighborhood). Therefore, prices of Chinese goods – everything from video games to sweatshirts – are likely to rise in dollar terms. That will happen whether or not China revalues the [yuan]."

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