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January CPI & PPI data released by the National Bureau of Statistics in China last night showed a continued decline in price inflation with Consumer Prices declining to a year-over-year growth rate of 1% while Producer Prices registered at -3.3%, the largest contraction in more than five years. The Chinese bond and equity markets rallied on speculation that the central bank will cut rates again in the wake of the data.

CPI:
Declining CPI brings a mixed blessing to leaders in Beijing. On one hand, just 6 months after grave concerns about skyrocketing food costs were dominating headlines, the most recent data shows that collapsing commodity prices have removed much of the pain for consumers at the register (see below).

{SEE TABLE 1 BELOW}

The dilemma facing the central bank now is how to coax consumers to loosen their purse strings. Governor Zhou Xiaochuan was quoted yesterday saying that the Central bank will balance interest rate and FX policy to get people shopping. Although a rate cut in the near term now seems likely, the overlapping cultural and economic incentives for Chinese consumers to save rather than spend –particularly members of the fragile emerging middle class who have been watching job losses among the lower wage earning classes warily, will not be overcome simply through rate cuts.

PPI:
The falloff in prices for energy commodities and base metals drove PPI to its lowest Y/Y levels since March 2002. The breakout in component costs below clearly reflects this decline in commodity prices (with the notable exception of coal which continued to show relative price pressure into year-end, though recent production cutbacks of as much at 20% by generators on the state electricity grid should soon provide some temporary demand respite).

{SEE TABLE 2 BELOW}

The recent increase in iron ore inventories reported by trade publications suggest that mills are taking advantage of lower prices as they gear up in anticipation of the massive stimulus programs which will begin to break ground in Q2.

Unlike the US and Europe, China has liquidity and the potential for massive growth in domestic demand; the question now is whether they can capitalize on this position of strength. We will have our Eyes trained on the Chinese Ox in the coming weeks as we look for more signs that Beijing’s leadership is working on solutions, both near and long term, to both drive growth and sustain it.

Andrew Barber
Director