By Zhou Xin and Simon Rabinovitch
Chinese inflation was lower than forecast at 4.9 percent in the year to January, but price pressures continued to build and will force the central bank to stick to its course of gradual monetary tightening.
Economists polled by Reuters had forecast a 5.3 percent rise in the consumer price index (CPI) following a 4.6 percent increase in the year to December, although talk swirled in markets on Monday that the figure could be below 5 percent.
Though the market cheered the softer-than-expected CPI, it may provide a false dawn and should be considered with caution mainly because recent indicators and developments still signal that upside risk to inflation persists, said Connie Tse, economist at Forecast PTE in Singapore.
In one sign of the accumulating pressures, core inflation, stripped of volatile food prices, jumped to 2.6 percent year on year, the highest since at least 2002, from 2.1 percent a month earlier.
In another sign, soaring global commodity costs pushed producer prices up 6.6 percent in the year to January, accelerating from 5.9 percent in December and well above the 6.1 percent rise forecast by analysts.
The large increase in PPI inflation suggests that price pressures will remain uncomfortably strong, at least for the next few months, said Brian Jackson, economist with Royal Bank of Canada in Hong Kong.
Asian stocks and global commodities were largely flat, having jumped on Monday when rumors of the lower-than-expected inflation figure first swirled through markets, easing fears that China would need to unleash aggressive monetary tightening.
The National Bureau of Statistics also announced an adjustment in the way it calculates consumer price inflation, saying that it better reflected the evolution in Chinese consumption patterns.
Housing was given a much larger share of the new CPI basket, while the weighting of food prices was reduced. These changes were consistent with an economy that is fast becoming more prosperous, allowing urbanites to spend a smaller portion of their incomes on basic needs and more on big-ticket items.
Many in the market had expected that the adjustment, conducted every five years, would lower the CPI, but the statistics agency said the adjustment had actually added 0.024 percentage point to January's reading.
February CPI is expected to be about 5.2 percent, and if it is significantly lower than that, we may conclude that inflation in China has changed fundamentally. Or we can say that the CPI indicator itself is quite doubtful in terms of reliability, said Gao Shanwen, chief economist with Essence Securities in Beijing.
But at least some investors and analysts took the statistics agency at its word, and said that lower inflationary pressure would reduce the need for a big dose of interest rate increases. China's main stock index was up 0.7 percent at 0511 GMT after soaring 2.5 percent on Monday.
Ting Lu, an economist with Bank of America-Merrill Lynch noted that the biggest surprise was the 10.6 percent increase in food prices year on year. Many had thought a larger rise was in store, because the Chinese New Year fell earlier in 2011 than 2010 and that was expected to push up food costs in January.
The implication here is that inflation pressure might be smaller than the market had thought, he said.
Last week, the Chinese central bank raised interest rates for the second time in just over six weeks. Trying to mop up the excess cash in the economy that has fueled inflation, Beijing has also raised banks' required reserves seven times since the start of last year and ordered them to issue less credit.
Despite these measures, Chinese officials remain concerned about the still rapid expansion of bank lending.
A Reuters poll showed that Chinese banks started the year with their usual lending frenzy, likely making about 1.2 trillion yuan in new loans in January.
That would amount to about 17 percent of the 7 trillion yuan in loans that many assume is the government's full-year target for 2011.
The central bank is expected to report the January lending data later on Tuesday.
Another worry is a drought that has beset China's major wheat-producing region since October, threatening to push up grain prices and fuel further food inflation.
The unfavorable weather conditions have raised supply-side risks for production of agricultural products, and simultaneously reinforced inflationary expectations, Qu Hongbin, chief China economist at HSBC, said.
(Additional reporting by Kevin Yao and Aileen Wang; Editing by Ken Wills and Neil Fullick)