2nd LD-Writethru-China Focus: July inflation stays tame, liquidity to remain abundant

An increase in the price of pork propelled China's consumer prices in July to their highest level this year, while deflation risks in industrial production loomed larger, official data showed on Sunday.

Analysts said China's inflation is and will be subdued, and they ruled out the likelihood of government actions to drain liquidity from the market.

The National Bureau of Statistics (NBS) said China's consumer price index (CPI) rose 1.6 percent in July. The index, which has been below 2 percent for 11 months in a row amid an economic slowdown, hit its highest level in 2015.

The CPI has risen over the last few months, mainly on the back of a surge in pork prices, according to senior NBS statistician Yu Qiumei.

The price of the staple meat in China is one of the most important factors the NBS considers when formulating the CPI. Prices climbed sharply by 16.7 percent in July.

China's inflation has entered a "pork price cycle." Before the price increase, pork prices had continuously declined over the past two years, hitting the profits of pig farmers who, in order to mitigate losses, cut down on the number of livestock they raised.

The Ministry of Agriculture predicted that pork demand will slightly exceed supply in the coming months. It said meat prices will continue to rise, but growth will be moderate.

The Ministry of Commerce (MOC) played down the price rise, calling it a normal market correction.

"The recent rise is a correction of the sharp price declines in the past two years," said MOC spokesman Shen Danyang, adding that the ministry will keep tabs on the market and work to stabilize the pork supply.

Zhang Jun, head of macroeconomic research with Morgan Stanley Huaxin Securities, said CPI growth will top 2.5 percent or even approach 3 percent at the end of the year.

"Annual growth will probably stand between 1.8 and 2 percent," Zhang said. The Chinese government aims to keep consumer inflation at around 3 percent for 2015.

Lian Ping, chief economist with the Bank of Communications, predicted consumer inflation in the world's second largest economy will be milder.

"The CPI growth will fluctuate between 1.5 and 2 percent in the second half, and the annual expansion will be around 1.5 percent," said the economist.

DEFLATION RISK

The picture at factories was much worse. The producer price index (PPI), a measure of costs for goods at the factory gate, fell 5.4 percent year on year in July, widening from the 4.8-percent drop seen a month earlier.

The July reading dipped to the lowest level since the end of 2009 and marked the 41st straight month of decline.

"Domestic demand remained sluggish, and commodity prices were on the decline. China still faces grim deflation risk," noted Qu Hongbin, chief China economist at HSBC.

In a sign of weak overall demand, China's imports nosedived by 8.6 percent in July. A sharp decline of 8.9 percent in exports also cast a shadow on the world's largest goods trader.

To make things worse, major commodity prices are lingering at a multi-year low, and there are no signs of quick recovery.

The World Bank predicted that energy prices will average 39 percent below 2014 levels this year, with metal prices down 16 percent and iron ore plummeting 43 percent.

Peking University economist Su Jian said weak commodity prices drive down the price of finished products, delaying investment and postponing consumption. Weak demand caused by shrinking business activity will in turn sink commodity prices.

"This will form a 'vicious circle,'" said Su.

CONTINUED EASING?

Worries have arisen that the central bank may tighten monetary conditions as the CPI recovers, but the bank hinted that it may not do so.

The central bank said in a quarterly report on Friday that China's inflation can be contained to a relatively low level.

The bank said it will employ multiple monetary policy tools to maintain "moderate" liquidity growth and try to lower financing costs so that the real economy can benefit from financial services.

"Although the Chinese economy is probably bottoming out, growth momentum is still anemic," said Zhang.

"It is unlikely that the central bank will deeply cut interest rates in the second half of the year, but it will not take actions to freeze liquidity, which is significant to bolster growth and stabilize the market," said Lian. Endi