Consumer Inflation in China Hits a 5 Year Low

China reigned supreme this morning when it released a lot of economic data. Most of which was ignored by the markets. China’s consumer price index (CPI) fell again, in September, to lows not seen since January 2010. This supports that China’s economy is losing steam and gives Beijing more room or further stimulus.

Consumer prices were up 1.6 percent from last year thanks to lower commodity and food prices. We had expected this number to come in at 1.7 percent after being up two percent in August. Whole sale prices contracted 1.8 percent, worse than the 1.6 percent expected contraction. Producer prices have been falling since February 2012, again thanks to declining commodity prices. Weakening demand and overcapacity are not helping as well.

We saw the AUD/USD fall after the news before recovering to trade around $0.87. The Shanghai Composite was up a marginal 0.2 percent after the news as was the Hong Kong Hang Seng Index.

These Inflation Numbers Could be Quite Unnerving

These numbers are quite disturbing. Deflation in Chinese factories are not new but we are now seeing deflation in their massive housing market. How much will this spill over into other sectors? That is the big question on investor minds. Inflation is now at 1.6 percent, well below the target set by Beijing at 3.5 percent. This was before the full impact in the softening oil prices was felt. We are now see contraction in home prices as well as excess capacity in factories and a local currency that is gaining value. Everything is pointing to worsening deflation. This means things will get far worse before getting better.

There is an upside. Most of this is benign inflation which gives policy makers in Beijing more room to enact stimulus. Stimulus measures could turn things around before they get too bad.

This past Tuesday, the People’s Bank of China (PBOC) cut short term borrowing costs for commercial banks. This is the second time in less than a month. They cut the interest rate on the 14 day repurchase agreements (REPO) by 0.10 percentage points to 3.4 percent. They last did this on September 18, when they slashed the rate by 0.20 percentage points to 3.5 percent. This is an example of a macroeconomic top to down approach. Consumers are now worried about economic growth slowing over the next several quarters.

Beijing is showing more tolerance to a moderate rate of growth. They are trying to move their economy to a domestic consumption from its current manufacturing growth model. Still, policy makers, will stay to the current script and enact small and targeted stimulus measures when needed. It is highly unlikely we will see a massive and aggressive monetary approach anytime soon. Expect more cuts in the reserve requirement ratio or RRR over the next few months.

China is working hard to achieve their target growth of 7.5 percent this year. Their goal is to realize a more stable and slower growth cycle going forward and it is likely they will cut their growth target for 2015 to seven percent. A recent statement from the ministry of finance support this as they feel a seven percent growth is more sustainable given the current outlook in China’s labor market. They will support this with further measures to help with job creation in order to spur overall economic growth.