China's annual consumer inflation rises to 2.7% in June from 2.1% in May, exceeding analysts' 2.5% forecast, as food prices jumped to 4.9% from 3.2%; central bank faces challenge of managing price risks even as economic growth slows

Cindy Allen

BEIJING , July 9, 2013 (Thomson Reuters Corp.) – * June CPI +2.7 pct yr/yr vs f'cast +2.5 pct

* June PPI -2.7 yr/yr vs f'cast -2.7 pct

* C.bank seen keeping policy stance neutral

China's annual consumer inflation accelerated more than expected in June but factory-gate deflation persisted for a 16th month, underscoring the policy dilemma facing the People's Bank of China as it worries about long-term price risks even as economic growth slows.

The central bank is seen keeping policy largely neutral in the near term to balance the need to keep the world's second-largest economy on an even keel while warding off inflation as well as possible property bubbles, analysts say.

"We believe the headline inflation data will not change monetary policy stance. We don't think the central bank will increase or cut interest rates within this year," said Li Wei, an economist for Standard Chartered Bank in Shanghai.

The National Bureau of Statistics said that annual consumer inflation quickened to 2.7 percent in June from May's 2.1 percent, partly because of the base effect.

The headline inflation number is still below the government's target of 3.5 percent and also below the benchmark one-year deposit rate of 3 percent.

Food prices jumped 4.9 percent in June from a year earlier, quickening from the 3.2 percent rise in May. Pork prices rose 1.1 percent year-on-year versus a fall of 4.9 percent in May.

Although inflation may stay benign in the coming months in the absence of an economic recovery, the central bank is worried about long-term inflationary risks, which could complicate policy, especially as property prices keep climbing.

The data "reduces the likelihood of interest rate cuts this year and that is not a good policy background to have," said Kevin Lai, an economist at Daiwa in Hong Kong.

"But I think inflation will ease by the end of the year as demand won't be strong."

The bureau also said China's producer prices fell 2.7 percent last month from a year earlier - the 16th consecutive month of deflation, compared with a drop of 2.9 percent in May.

Economists polled by Reuters had expected consumer inflation of 2.5 percent and factory-gate prices to fall 2.7 percent in June.

CREDIT SQUEEZE

Last week, China's cabinet laid out plans to cut off credit to force consolidation in industries plagued by overcapacity as it seeks to end the economy's dependence on extravagant investment funded by cheap debt.

China's largest private shipbuilder, China Rongsheng Heavy Industries Group Holdings, was reported this week to have cut 8,000 jobs in recent months, falling victim to too much capacity in a slow international market.

The central bank also allowed short-term interbank borrowing costs to spike to close to 30 percent on June 20, a blunt warning to overstretched lenders that they must bring risky lending under control.

The cash crunch - caused by factors including fast credit growth, the regulatory deposit reserve requirement and a crackdown on hot money inflows - is abating after the central bank signalled its readiness to soothe market volatility.

But despite its efforts so far the central bank has limited room to manoeuvre on the policy front. Cutting interest rates may lend a support to the economy but runs the risk of inflating a property bubble, while tightening may put additional pressure on the economy amid the global uncertainty.

China's annual economic growth likely slowed to 7.5 percent in the second quarter from 7.7 percent pace in the previous quarter - two consecutive quarter of slower growth, according to the poll. The statistics bureau is due to released data on GDP, along with factory output, investment and retail sales, on Monday.

Beijing hopes 2013 growth could hit 7.5 percent - impressive by world standards but the slowest in 23 years for China.

But President Xi Jinping and Premier Li Keqiang have shown a greater tolerance for slower economic expansion than their predecessors, focusing on reforms rather than short-term stimulus.

Beijing would tolerate quarterly growth slipping as far as 7 percent year-on-year before looking to lift the economy, according to government economists from top think-tanks.

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