China's inflation eased in May, a welcome trend that analysts said would continue for the rest of the year as food prices had started falling after surging over the past year.

The consumer price index (CPI), the main gauge of inflation, rose 7.7 percent last month, marking its first significant drop since last year, the National Bureau of Statistics (NBS) said on Thursday.

The CPI rose 8.5 percent in April, up from 8.3 in March and down from the 12-year high of 8.7 percent in February.

However, while inflation was decelerating, prices would remain high this year, and the situation might trigger further tightening and price reforms involving energy and resources, said analysts.

CPI to drop further

The CPI would continue to fall for the rest of the year with declining food prices, according to the China International Capital Corp. (CICC).

The rate of increase in food prices, a major driver behind China's high inflation, dropped 2.2 percentage points to 19.9 percent in May.

As stocks of live pigs and the yield of rape vegetables increased, the trend would likely to continue because of increasing supplies and an expected bumper harvest.

China has since last year introduced a series of incentives, including direct subsidies and government-funded insurance, to boost agricultural production.

Li Huiyong, an analyst with Shenyin Wanguo Securities, said that the devastating earthquake in Sichuan Province on May 12 had a limited impact on food prices as the grain and pork output in the quake regions accounted for a tiny portion of the nation's total.

Liang Hong, chief China economist with Goldman Sachs, said the easing in May might mark a start of prices softening during the remaining period of the year if the government stuck to tight monetary policies.

The People's Bank of China (PBOC), the central bank, ordered a full percentage point rise in the reserve requirement ratio on Saturday to enhance liquidity management and tame inflation. The larger-than-expected hike followed 14 increases in the reserve ratio and six interest rate hikes since last year.

This move dashed market hopes the PBOC would relax monetary policy as the economy faced a worrisome slowdown on weaker export growth and the impact of several crises, from the worst blizzards in five decades earlier this year to last month's 8.0-magnitude quake.

Prices to remain high

Inflation also eased because of the high base of comparison from late last year, but absolute prices would continue to climb all through the year, said Hu Yuexiao, an analyst with Shanghai Securities. "The inflation situation is still very grim and the CPI is set to exceed the government target of 4.8 percent for 2008," said Hu.

The Bank of China (BOC) forecast the CPI will rise 8.3 percent in the second quarter and 6.8 percent the whole year.

The quake would not change economic fundamentals, but the massive investment required for reconstruction might add new inflationary pressures, the leading commercial bank said.

The acceleration in the producer price index (PPI) in May might lead to a rebound in the CPI sometime later this year as producers pass the higher costs on to consumers, analysts said.

The PPI surged 8.2 percent in May on higher costs of energy, resources and labor, after gaining 8.1 percent in April, the NBS said on Wednesday.

This also deepened worries that higher factory-gate prices might lead to more worrisome broad-based price rises, in contrast to the current structural hikes mainly caused by food.

"The pressures for broad-based price rises are still the biggest risk for the macro-economy," the central bank said in a report published early the month.

More tightening, price curbs?

Chinese authorities still needed to stick to a tight monetary policy and raise interest rates "at a proper time," following the reserve hike on Saturday, to more effectively curb inflation, the BOC said in a research report released on Tuesday.

Rate hikes would help to end negative interest rates to become one of the most effective weapons against inflation, the report noted.

The central bank, however, has refrained from boosting interest rates this year, fearing that could attract more overseas speculative funds after the sharp rate cuts in the United States.

With difficulty in reaching a consensus on rate hikes, the PBOC would use more bill sales, reserve ratio increases and administrative intervention to curb excess liquidity and inflation, the report added.

The trade surplus, although shrinking in recent months, continued to pump a huge amount of liquidity into the banking system, partly blamed for price surges.

To curb inflation and support post-quake building, the National Development and Reform Commission (NDRC), the top economic planning agency, ordered on Wednesday temporary price controls on construction materials such as steel, cement, timber and glass.

Earlier the year, the NDRC ordered similar steps for basic necessities ranging from grain, edible oils, meat, milk and eggs to liquefied petroleum gas.

The decelerating inflation might offer an opportunity for lifting some price controls, including raising fuel prices, in the second half of the year, CICC added.

Price controls have managed to limit the inflationary surge, but they were also widely said to have cut corporate profit growth or even caused losses and made businesses unwilling to increase output, which in turn fanned inflation.

(Xinhua News Agency June 13, 2008)