China’s central bank, like many other central banks, targets a specific level of inflation, in China’s case it is 2%. Received economic wisdom has it that a low level of annual price inflation is good for the economy and that deflation (negative inflation) can produce a drag on the economy by dampening consumer demand.
Recent data suggests that China’s inflation rate has fallen back to 1.4%, its lowest level since 2009. The decline in prices was faster than analysts had expected, most thought that inflation in China would be running at 1.6%. For comparison, annual inflation in the 18 nation Eurozone came in at 0.3% last month. The reason for the decline in China’s inflation rate is much the same as in Europe. Demand for consumer goods is muted around the world which means that demand for Chinese goods remains subdued. Domestic demand in China is not strong enough to pick up the slack and the prices of commodities and food have eased recently.
Producer prices (the price that suppliers sell their goods at) declined by a further 2.7% year-on-year and have been falling for the past 33 months. The fall, again, was more than analysts had predicted and has been linked to slowing demand for industrial goods (internally) because of a cooling property market.
A move to cut interest rates by the central bank last month by 0.25% from 3% was designed to boost the economy by making the money supply cheaper (this also increases inflationary pressure). The rate is considerably higher than those of other major central banks in the Eurozone, UK, USA and Japan which are still at or below the 0.5% mark. This means that the other major central banks have little or no scope to push inflation up by supplying cheaper money since rates are about as low as they can go.
China can also ease the monetary supply by reducing the reserves that banks are obliged to hold on their books. The rates were pushed up to take heat out of the housing market by reining in borrowing.
