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Monetary policy faces fork in road
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Economists said yesterday the slower-than-expected August consumer price growth may lead to a loosening of monetary policy, but they remained divided on the extent of such a relaxation.

A package of fiscal stimulus has been widely greeted, including tax cuts and reconstruction of the earthquake-hit area.

The consumer price index, the main gauge of inflation, eased to 4.9 percent in August from 6.3 percent in July, statistics showed yesterday. The CPI slowdown was much sharper than the market expected.

The producer price inflation accelerated to 10.1 percent in August from 10 percent a month ago.

The continued moderation of the headline CPI has eased pressure on the People's Bank of China to further tighten monetary policy in the near term, said Sherman Chan, a Moody's Economy.com economist yesterday.

"Such rapid deceleration of CPI growth must be great news to Chinese policy makers, who had made controlling inflation their top priority early this year," Chan said.

The stark drop of CPI reduces the possibility of more interest rate hikes, said Jan Lambregts, director, head of research Asia of Rabobank International. Previously, he had expected the central bank to raise the interest rate by 27 basis points, or 0.27 of a percentage point, in the fourth quarter. However, with the August inflation number that possibility had dropped, he said.

Despite moving in the desired direction, CPI growth was not free from upside risk, economists cautioned.

"Higher production costs have to be passed on to consumers eventually, even if some businesses are willing to squeeze profit margins,'' Chan said.

''Beyond a certain point, holding prices constant means operating at a loss. At that time, options are to shut down or raise prices. Either path will lead to strong inflationary pressures, as the former implies reduced supply," Chan said.

Lambregts agreed prices would rise.

"So far producers have been absorbing large share of higher input prices rather than passing them on," he said. "Ultimately, they will be forced to pass on the pressure."

Lambregts said he still expected the central bank to keep the general lending quota tight except for small and medium businesses and the rural sector.

He said he also maintained his expectation that the central bank may raise the reserve requirement ratio by 50 basis points, or 0.5 percentage point, in 12 months.

The central bank has raised the reserve requirement six times this year to shore up the measure to a record high of 17.5 percent.

Some economists, however, said the probability of a policy reversal may rise significantly in the coming months, as global economic conditions continued to deteriorate and domestic corporate sectors increasingly felt the pain of growth slowdown.

"The question about a policy turnaround is when, not whether. And we think the earliest possible time is during the fourth quarter of this year," said Citigroup in a research report yesterday.

Citigroup said it expected monetary policy may ease gradually with initial steps like relaxation of credit controls, adjustment of reserve requirement and even interest rates cuts if inflation remained under control but growth decelerated.

While economists were divided over the interest rate and reserve requirement, they agreed on a further appreciation of the local currency.

The Chinese yuan appreciated against the United States dollar by more than 6 percent in the first half of the year.

Lambregts said he expected the local currency to appreciate 8.2 percent this year with the appreciation pace slowing down to 4 percent next year.

Economists from Standard Chartered Bank said the yuan would keep rising against not only the US dollar but a basket of currencies and "the worse times are still ahead for China's exporters."

Citigroup said yesterday that it expected the yuan to reach 6.7 against the US dollar at the end of 2008 and 6.4 at the end of 2009.

(Shanghai Daily September 11, 2008)

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