comments on China's Jan headline CPI

from：J.P.Morgan

China: January CPI inflation decelerated further to 1.0%oya; non-food CPI fell by -0.6%oya

China's Jan headline CPI inflation was slightly above marketexpectations at 1.0%oya (J.P. Morgan: 1.3%; consensus: 0.8%),compared to 1.2% in Dec. This is the lowest reading since Jul-06.Seasonally-adjusted, headline CPI fell for a fifth consecutive month anddropped by -0.2%m/m, sa last month, with the underlying sequentialtrend contracting at -5.0%3m/3m, saar through Jan.?

Detail breakdown of Jan data suggests that food price inflation eased to4.2%oya in Jan, while non-food CPI dropped at -0.6%, the first negativereading in six years. There is notable fall in fuel/utility price inflation.Nonetheless, the decline in non-food price inflation is rather broad-basedacross a wide range of goods and services. While part of the moderationin non-food CPI likely reflects less pass-through of input cost due toeasing commodity prices, there is no doubt that easing end demand hasweighed on corporate pricing power. PPI fell further by -3.3%oya in Jan,compared to -1.1% in Dec. Seasonally adjusted, this translates into a-1.6%m/m, sa decline, with the underlying trend contracting at -23.3%3m/3m, saar through Jan.?

Headline CPI has been steadily easing in recent months. The first andmost powerful leg of disinflation is driven by setback in food and energyprices, while second leg of disinflation, however, may be driven by lowercore inflation with growth of wage and goods/service prices tempered byweak economy and final demand. We expect headline CPI to fall in thecurrent quarter, the first instance of outright deflation since 2002. Risk of rise in deflation expectations is higher than that of inflation expectationsin China, given the ample or even excessive production capacity in manyindustries, as well as the massive supply pressure in the labor market.Growing deflation expectations are set to dampen domestic confidenceand further delay household spending and capital investment. This coulderode producers?pricing power, reinforcing a deflationary spiral. Modestuptick in steel and coal prices in a sign of confidence about final demand,and higher property transaction volume suggest that China is not close tothis point yet.

However, market participants may need more evidence tobuoy their confidence, and aggressive fiscal stimulus and monetaryeasing would be necessary to boost confidence and stem deflationexpectations. Accelerated money supply and loan growth recently couldfurther delay interest rates and RRR cuts by the central bank and limitthe downside for policy rates. However, despite the central bank's significant rate cuts in earlier months, with headline inflation collapsing,real interest rate has been rising notably, especially in the context of thereal economy's subdued 1.5%q/q, saar growth pace in 4Q08,discouraging domestic consumption and investment. Hence, we expectfurther cuts in interest rates and RRR ahead.