China's central bank on Monday warned of deflation in the near term caused by continuing downward pressure on prices.

Commodities prices were low and weak external demand could exacerbate domestic over-capacity, the People's Bank of China (PBOC) said in an assessment of fourth-quarter monetary policy.

"Against the backdrop of shrinking general demand, the power to push up prices is weak and that to drive down prices is strong," the PBOC said. "There exists a big risk of deflation."

China's consumer price index (CPI), a major gauge of inflation, rose 1 percent in January from a year earlier. In that period, the producer price index (PPI), a measure of inflation at the wholesale level, dropped 3.3 percent.

But the PBOC also warned of medium and long-term inflation risks.

As the central banks worldwide injected a huge amount of liquidity into the financial system, commodities prices could repeat earlier rallies if market confidence recovered, it said.

The PBOC stated that China's economy faced further downside risks because of slackening external demand, over-capacity in some sectors and increases in urban job losses.

The gross domestic product expanded at a slower rate of 6.8 percent in the fourth quarter of 2008, as exports slumped and the property sector sagged, dragging down growth for the whole of 2008to a seven-year low of 9 percent

But China had huge market potential and as the macro controls started to take effect, its economy was likely to maintain stable and relatively fast growth, it said.

To spur growth, the PBOC said it would ensure ample liquidity in the banking system and promote the reasonable and stable growth of credit.

It also reaffirmed that China would keep the Renminbi (RMB) exchange rate basically stable, while making it more flexible in a self-initiated, gradual and controllable manner.

(Xinhua News Agency February 24, 2009)