Chinese Consumers Catch a Break After a Three Year Punch in the Wallet

China’s CPI falls 1.6%

March 10 (Bloomberg) — China’s consumer prices fell for the first time since 2002 after commodity costs declined, stoking concern that deflation will undermine efforts to revive the world’s third-biggest economy.

Consumer prices dropped 1.6 percent in February from a year earlier, the statistics bureau said today, after gaining 1 percent in January. The median estimate in a Bloomberg News survey of 10 economists was for a 1 percent decline. Producer prices fell 4.5 percent, the most in a decade, after a 3.3 percent decline.

The drop in prices raises the risk that deflation will become entrenched, squeezing company margins, prompting wage cuts and eroding consumer demand. Premier Wen Jiabao is relying on a 4 trillion yuan ($585 billion) stimulus package to spark a recovery after a collapse in exports dragged economic growth to the weakest pace in seven years.

“The government has to make sure its stimulus package kicks in in time to boost domestic demand,” said Wang Tao, a Beijing-based economist at UBS AG. “Faltering global demand will result in exporters selling more goods back to China’s domestic market, adding deflationary pressure.”

Inflation climbed to the highest in more than a decade in February 2008 as a week-long Lunar New Year holiday boosted spending and blizzards disrupted food supplies. This year, the holiday was in January.

Metal and oil prices have fallen because of weaker demand caused by the global economic slump. China’s food prices, which account for about a third of the consumer-price index, have also cooled.

Volkswagen Cuts Prices

Manufacturers cutting prices in China include Volkswagen AG, which reduced last month the prices of some locally made models by as much as 12 percent amid tumbling demand. House prices in 70 cities fell 1.2 percent in February from a year earlier, the biggest drop since data began in 2005, the government said today.

China’s economy, which expanded 6.8 percent in the fourth quarter, may grow 6.7 percent in 2009, the smallest gain in almost two decades, according to the International Monetary Fund.

A trend toward global deflation is becoming more obvious as the international financial crisis keeps spreading, Premier Wen said March 5 in his annual speech to China’s parliament, as he reaffirmed the nation’s 8 percent growth target for this year.

In Japan, consumer prices failed to rise in January for the first time in more than a year.

Still, European Central Bank President Jean Claude Trichet, who chaired a meeting of global central bankers yesterday in Basel, Switzerland, said deflation was “not something we consider a high probability at all at a global level.”

Spur to Spending

Temporary deflation in China may spur consumer spending and cut production costs, according to UBS’s Wang. “The current low-price environment has also offered an opportunity for the government to raise controlled prices such as utility prices including electricity and water,” she said.

China isn’t yet facing “typical” deflation, where falling prices are accompanied by shrinking loans and money supply and an economic recession, central bank vice governor Yi Gang said, according to the state-run Xinhua News Agency.

China’s banks extended 1.6 trillion yuan of loans in January, double the record set a year earlier, after the government removed quotas limiting lending. Money supply expanded at the fastest pace in more than a year.

The central bank has “sufficient” policy tools to combat deflation, Yi said, without elaborating.

Likely declines in consumer prices from February through June won’t trigger “aggressive” interest-rate cuts, partly because the government’s stimulus package will be inflationary, said Sun Mingchun, a Hong Kong-based economist at Nomura Holdings Inc.

The central bank may make a single 27 basis-point reduction this year, taking the one-year lending rate to 5.04 percent, as “a symbolic reaction to deflation,” Sun said.