Are China's Inflation Woes Ending?

09/09/2011 12:11 pm EST

Focus:

Jim Jubak

Founder and Editor, JubakPicks.com

China’s official inflation rate fell to 6.2% in August from 6.5% in July, according to data released today, September 9.

It’s too soon to say that July’s 6.5% marked the peak in inflation for this cycle, but nonetheless the drop to 6.2% is good news for those investors waiting for an end to the People’s Bank of China’s war on inflation. That war has led to five increases in China’s benchmark interest rate in the past year, and persistent fears that the bank’s monetary policies would crash economic growth.

China’s economic growth rate is projected to slow to just below 9% this year, and then drop to 8.3% in 2012.

China’s central bank last raised interest rates in July, and the bank increased reserve requirements most recently on August 27. The one-year lending rate stands at 6.56%, and the interest rate paid on bank deposits at 3.5%. The country’s largest banks are required to keep 21.5% reserves after the latest move.

I don’t think the drop to 6.2% will lead to anything like a quick cut in interest rates—too much of today’s drop could be wiped out by a shift in oil or pork prices. But I think the People’s Bank is likely to go on hold for a while, joining the central banks of Korea, Indonesia, Malaysia, and the Philippines, all of which held rates steady in decisions announced September 7.

(And, yes, the official inflation rate in China seriously understates the actual inflation rate, estimated to be twice as high as the official rate. It’s a shock, I know, to learn that any government in the world would ever rig the inflation numbers. Never happen in the United States, of course, right? But the People’s Bank uses the official rate to set monetary policy, so even if everyone knows the official rate is way too low, for financial markets it’s the official rate that counts.)

In my opinion, it will take another month or two of good inflation news to convince financial markets that the cycle of interest-rate increases has come to a temporary end.

That belief would be good news for China’s stocks, which have suffered from fears of a domestic economic crash and higher interest rates since peaking last November.

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own positions in any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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