Monday, December 13, 2010

China house prices, inflation and monetary policy

China raised the Required Reserve Ratio (RRR) a further 50bps on Friday, following the release of house price and inflation data for November. The increase in the RRR is effective from December 20.

House prices continue to rise. Prices were up 0.3% in the month and 7.7% in the year. That’s a slowdown in the annual rate, but the monthly rate of increase was the third in a row after increases of 0.5% in September followed by 0.2% in October.

Inflation leapt again in November with the annual rate hitting 5.1%. This is up from 4.4% in the year to October and 3.6% in the year to September. Food prices are the main culprit yet again, but there were signs this month of inflation pressure becoming more broadly based. Food price inflation was 11.4% over the year, while non-food inflation rose 1.9%. Over the month, however, “clothing” and “residence” prices also recorded significant increases.

There is speculation this may be a peak in annual inflation as flood-related vegetable prices begin to retreat, but the broader base of price increases shouldn’t be ignored.

We believe further tightening in monetary policy is desirable. This can take a number of guises, but we believe a combination of further RRR increases, an increase in benchmark interest rates and faster appreciation of the CNY are all necessary.

It is essential the authorities take the need to keep inflation in check seriously. Regular readers of our research know we believe the biggest threat to rising emerging market prosperity is any lack of commitment on the part of monetary authorities to take whatever action is required to tame inflation. Growth is holding up well in China. We believe inflation can be tamed with a soft landing.

That view is not without risks. It is also important not to overdo the tightening and damage growth prospect unnecessarily. But that requires early and pre-emptive action. Leave it too late and the tightening in monetary setting may have to become more aggressive, which would be more damaging to growth prospects.