China’s Inflation Slows to 1%, Producer Prices Tumble

By Kevin Hamlin and Yidi Zhao

Feb. 10 (Bloomberg) -- China’s producer prices tumbled by the most in almost seven years and inflation cooled to the weakest pace since 2006 as the government struggled to revive growth in the world’s third-biggest economy.

Consumer prices rose 1 percent in January from a year earlier, the statistics bureau said today, after gaining 1.2 percent in December. Producer prices fell 3.3 percent after a 1.1 percent decline.

Lunar New Year celebrations last month may have prevented a bigger decline in the inflation rate as the economy slumped because of plummeting export demand. Central bank Governor Zhou Xiaochuan said today that China may use interest rates and foreign-exchange policy to cut the nation’s savings rate, boost consumption and sustain economic growth.

“Inflation could have been close to zero or worse if not for the Chinese New Year, because vegetable prices and grain prices went up,” said Wang Tao, China economist at UBS AG in Beijing.

Government bonds climbed, spurring speculation that the central bank may cut interest rates for the sixth time since September. The yuan rose to 6.8330 against the dollar as of 11:42 a.m. in Shanghai, from 6.8338 yesterday.

The global slowdown helped to trigger the drop in producer prices by prompting declines in costs of imports such as metals, the statistics bureau said in a statement.

McDonald’s Cuts Prices

McDonald’s Corp., the world’s biggest restaurant chain, said it cut prices in China last week to keep meals “affordable,” after the nation’s fourth-quarter economic growth was the slowest in seven years.

China’s slumping exports and economic slowdown have cost the jobs of 20 million migrant workers and led to the closure of 4,000 toy factories last year.

Slowing inflation leaves more room for interest-rate cuts to increase domestic demand, as Zhou urges the nation to boost consumption to sustain growth.

“We need a comprehensive package to do the task of lowering the savings rate, including exchange and interest rates,” Zhou told a conference of central bankers in Kuala Lumpur today. “We need to emphasize internal demand, that is domestic consumption, especially in rural areas. We need to change the consumption pattern.”

Inflation was faster than the 0.8 percent median estimate of 15 economists surveyed by Bloomberg News. The slump in producer prices was steeper than the survey’s forecast of a 2.6 percent decline.

Deflation Risk

The drop in producer prices “shows a rate cut is possible in the near term,” said Zhang Liling, a Shenzhen-based fixed income trader at China Merchants Bank Co., the country’s sixth largest lender.

The yield on the 3.68 percent note due in September 2018 fell 1.2 basis points to 3.3 percent, and the price of the security climbed 0.10 per 100 yuan face amount to 103.27, as of 11:32 a.m. in Shanghai.

China may report deflation in the first half of this year because of reduced commodity prices and because comparisons will be with inflation that reached an 11-year high of 8.7 percent in February 2008, said Jing Ulrich, head of China equities with JPMorgan Chase & Co. in Hong Kong.

Consumer prices “should stabilize towards mid-year” as the government’s 4 trillion yuan ($585 billion) stimulus package boosts consumption, Ulrich said.

The nation’s worst drought in 50 years may push up grain prices.

Pressure to Cut Rates

The inflation slowdown “puts more pressure on the central bank to cut interest rates further,” said Peng Wensheng, head of China research at Barclays Capital in Hong Kong. “In the short term, the downward pressure is on prices.”

The key one-year lending rate stands at 5.31 percent after 2.16 percentage points of reductions in 2008 that followed the collapse of Lehman Brothers Holdings Inc. The central bank is yet to make a reduction this year.

Peng expects the rate to be cut a further 81 basis points this year after the economy grows as little as 5 percent this quarter.

China’s economy expanded 9 percent in 2008 after a 13 percent gain in 2007 that pushed it past Germany to become the world’s third-biggest. In the fourth quarter of last year, growth cooled to 6.8 percent, the weakest pace since 2001, on the export decline and a slump in property.

To contact the reporters on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net;