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The Globe and Mail

China looks beyond interest rates to cool inflation

Chinese shoppers queue to buy discounted eggs at a supermarket in Hefei, in eastern China's Anhui province, on May 10, 2011.


China may be battling high inflation, but may still escape the need to hike interest rates again.

That doesn't mean authorities won't tighten in other ways, though, such as another boost to bank reserve requirements to cool things down without the need for a higher policy rate.

Annual inflation in China dipped in April to 5.3 per cent, down ever so slightly from the March pace of 5.4 per cent, according to fresh data released Wednesday. But other indicators, such as industrial output and retail spending, suggest growth may be cooling somewhat.

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"The above-consensus figure for consumer prices means that inflation will probably remain at the top of the list of policy concerns," said Mark Williams, senior China economist at Capital Economics in London. "But the activity data imply that economic growth may be weaker than previously thought."

What that suggests, according to Mr. Williams, is that the People's Bank of China may not want to raise interest rates again, though it is likely to boost the reserve requirements for the country's banks.

"Further interest rate hikes cannot be ruled out, but we wouldn't be surprised if many officials outside the People's Bank think that too risky following the latest activity data," he said. "Reserve requirements will continue to rise, though, to offset the expansionary impact of foreign exchange reserve purchases. The last three moves have each come on the 17th or 18th of the month. We expect another move imminently."

There's another factor here, which could play into the demands of many countries for currency appreciation in China, a sore spot in international trade, particularly between Washington and Beijing.

"An obvious solution would be to allow the exchange rate to play more of a role in lowering price pressures," Mr. Williams said.

"The renminbi has weakened since mid-2010 in trade-weighted terms and April's trade figures indicate that exporters remain in good shape. If export sector employment is not too badly affected, as seems likely, a stronger currency should also support household spending by raising real incomes. The government seems to have warmed to this idea, judging by recent comments."

BMO Nesbitt Burns economist Beijamin Reitzes appears to agree, on the issue of the currency, though not necessarily on holding off on rate increases."

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"CPI dipped less than expected to 5.3 per cent year over year on the month," Mr. Reitzes said. "That's the second straight month above 5 per cent and suggests that China will be tightening monetary policy further. While more rate hikes are likely, faster yuan appreciation appears increasing probable as well, with the National Bureau of Statistics noting that pressure from imported inflation remains high."

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Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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