China's Inflation Is Rising - but All Eyes Are on Deflationary Risks

The latest data out of China today shows China's inflation is rising. However, it's China's deflation risks that have everyone talking.

ChinaThe National Bureau of Statics said today (Thursday) that China's consumer price index (CPI) rose 2% year over year in August and reached a one-year high. The rate was a notable jump over July's 1.6% rise. It also topped consensus forecasts of a 1.8% to 1.9% rise.

But it was a 3.7% surge in food costs that was responsible for the CPI's increase, not improving economic activity. The cost of fresh vegetables jumped 15.9% last month, and pork prices climbed 19.6% from a year earlier on cramped supply.

While the latest CPI number was a marked improvement both month over month and YOY, China's central bank will still likely proceed with additional monetary easing. That's bullish for markets.

"Despite the pickup, the CPI figure still is not a threat for Beijing to change its policy stance, especially when factory-gate prices remain in the deflationary territory," Fan Zhang, an economist with RHB Research, told The Wall Street Journal. "China's central bank is expected to keep easing its monetary policy throughout the year."

But here's why all the buzz is focused on deflation in China...

China's Inflation Overshadowed by These Numbers

The country's producer price index (PPI), measured as goods leaving factories, slumped 5.9% YOY in August. That missed expectations of a 5.5% decline and was worse than the 5.4% slide in July. August's dismal PPI showing marked the 42nd straight month of declines.

China's manufacturers slashed prices at the fastest pace in six years in August amid lower commodity prices and waning demand. Both signal persistent deflationary risks and have stoked expectations for additional stimulus measures from the People's Bank of China.

With the PPI remaining negative for more than three years, here's what economists are saying about these latest numbers...

"The risk for China is still deflation, not inflation," Kevin Lai, chief economist Asia Ex-Japan at Daiwa, told Reuters. "PPI deflation will eventually filter down to affect CPI, and aggregate demand will continue to be weak."

Li Huiyong, an economist at Shenyin & Wanguo Securities, agrees, adding that the PPI slump is very worrying. "It could affect corporate profitability, which in turn could affect consumption and the economy," he told Reuters.

A string of dispiriting Chinese economic reports has raised concerns about the health of the world's second-largest economy. Trade data released this week showed continued weakness in domestic demand. Imports to China tumbled 13.8% YOY in August. That was significantly worse than July's 8.1% dip. Earlier this month, China's official manufacturing purchasing managers index for August fell to its lowest level in three years.

But according to Money Morning Chief Investment Strategist Keith Fitz-Gerald, many of these concerns are overblown.

"The real risk here is something nobody's talking about - that Beijing uses current market conditions as an excuse to slam down on the economic reforms that have gotten it this far," Fitz-Gerald said. "If you think things have been wild now, imagine what happens if Beijing actually cuts off trade and reverts to Soviet-style communism rather than the capitalist version they've adopted."

As Fitz-Gerald points out, growth in the nation is undoubtedly slowing, but it won't just stop completely.

"Growth there may slow, but it won't grind to a halt, barring a complete policy reversal from Beijing... and that's something 1.367 billion consumers will make sure never happens," he explained.

China's stock market reacted cautiously to Thursday's data. The Shanghai Composite Index ended the day down 1.4% at 3,197.89. The smaller Shenzhen finished with a 1.6% decline at 1,851.45.

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