Can policy makers in Beijing control China's decent?

By chris Tedder, Research Analyst Forex.com

Inflation data started the rumours about the PBoC, with January's rise of 4.5%y/y in consumer prices representing the first time the headline figure has increased over the previous month since July last year, when inflation was around 6.5%y/y. If this figure does deter policymakers from further loosening, it could limit Chinese growth prospects and in turn increase the chance of a hard landing for the world's second largest economy.

However, we do suspect that these figures have caused Beijing to reconsider its position. Firstly, the Chinese lunar New Year has historically caused volatility in the following month's CPI data and on most occasions led to temporary spike. Thus, once we take out the holiday impact out of equation, inflation may still be declining. But the market will have to wait until February's figure for confirmation that CPI inflation is resuming its moderating trend. Nevertheless, we are predicting the headline figure to fall to 3.5-4% after the effects of the New Year have eroded.

The same distortion can be seen in recent trade figures out of China. China's trade surplus increased to $27.3bn in January, led by a massive decline in imports of 15.3%y/y. Whilst some of the decline in imports can be attributed to scores of manufactures shutting down production during the New Year holiday, it is the second month of consecutive declines. This paints a worrying picture of the domestic demand situation in China and may point to harder slowdown than economists predicted.

Furthermore, Chinese exporters have been hit hard by weak levels of demand from its largest trading partner, Europe. Export growth has been on a gradual decline since September last year, representing a slump from +24.5 to -0.5. Given the predicted levels of growth in Europe over next few years China's export sector may continue to suffer and accordingly China may have to find demand in other markets. Yet, right there is no viable alternative that can fully account for the pre-European financial crisis levels of growth.

What does this mean for monetary policy? We maintain our view that the PBoC will have a relatively prudent stance involving selective easing. The PBoC's reluctance to cut the required reserve ratio (RRR), combined with improving global conditions and domestic growth that is moderating within targeted levels, support over view of discerning policy loosening. Nevertheless, we are still predicting RRR cuts and more growth stabilising measures by Beijing to help control the descent in the country's GDP growth and in turn avoid a hard landing.

Overall, Beijing still has a lot of room to move in regards to policy and stimulating growth, thus we expect that China will avoid a hard landing. However, a continued slowdown in China will have impacts for commodity demand and corresponding raw material based economies. Furthermore, overall risk sentiment should remain fairly jittery to news stemming from the second largest economy in the world.