Chinese consumer inflation spurted to a 16-month high in February and a raft of economic data displayed broad-based strength, providing fresh arguments for policy tightening sooner rather than later.
The pace of credit growth halved in February, as expected, but some economists said the central bank would probably not wait long before increasing banks' required reserves for a third time this year and perhaps even raising interest rates or resuming gradual appreciation in the yuan.
Given the pace of real activity growth, which is well above potential level, and an inflation rate which is already at around 3 percent, we believe it is vital for the government to take more decisive measures to tighten the economy to prevent overheating, Goldman Sachs economists Yu Song and Helen Qiao said in a report.
However, the People's Bank of China took the inflation figure in its stride, with Governor Zhou Xiaochuan saying the rise in prices was in line with expectations. The main Shanghai stock index <.SSEC> ended the day little changed after initially dropping on the view that Beijing might need to hasten its policy tightening.
Consumer price inflation quickened to 2.7 percent in the year to February from 1.5 percent in the year to January, handily beating forecasts of 2.3 percent. The government wants to limit inflation for the whole year to 3 percent.
Tao Wang with UBS in Beijing was one of several economists who said the jump in February largely reflected a low base of comparison from a year ago, when the economy was slumping, as well as the impact of last month's Lunar New Year holiday.
It will, though, give the market an expectation of a more imminent rate hike. Our forecast is that a rate hike should happen relatively soon, if not this month then probably early in the second quarter, she said.
Asian stocks <.MIAPJ0000PUS> fell nearly 0.3 percent and European stock futures signaled a lower start as investors priced in a tough policy response.
But comments by Chinese officials suggested these global markets might be getting ahead of themselves.
Sheng Laiyun, the spokesman for the National Bureau of Statistics, said inflation would remain mild and controllable and blamed February's rise on holiday spending and bad weather, which pushed up the price of food.
Su Ning, a deputy central bank governor, also cited the Lunar New Year effect and said China was not yet experiencing inflationary pressure.
Inflation now exceeds the 2.25 percent interest rate on 12-month certificates of deposit, raising the risk for policymakers that savers withdraw their cash from banks and plunge into the already bubbly property market.
Pipeline price pressures are also building. Annual factory-gate inflation quickened to 5.4 percent in February from 4.3 percent in January. Economists had forecast 5.2 percent.
Factory output exceeded expectations, expanding 20.7 percent in January and February from year-earlier levels, while retail sales growth of 17.9 percent was just a touch lower than forecast. Both readings marked an acceleration from December.
Only urban investment in fixed assets such as roads and factories slowed from a year earlier, when the government was launching its 4 trillion yuan ($585 billion) stimulus package.
Still, investment growth of 26.6 percent in January and February beat market forecasts of a 26.0 percent rise.
The statistics office produces a combined figure for the first two months to iron out distortions due to the timing of the Lunar New Year holiday, which varies from year to year.
RATE RISE TIMING
Economists tied the underlying strength of the economy above all to the ready availability of cheap credit.
Although loan growth halved in February to 700 billion yuan, the total was still high given that it was a holiday-shortened month. And the proceeds of a lot of last year's lending are still on deposit with banks, ready for companies to spend.
Yet not all economists believe major monetary tightening is imminent. They argue that the government remains wary of the fragility of the global recovery, despite strong export data released on Wednesday, and is already slowing its infrastructure spending. Banks have been ordered to scale back lending and rules tightened to deter speculative property buying.
Beijing has continued to successfully use incremental tightening measures to slow the pace of economic growth back to a more sustainable level from last year's hyper-stimulated rate, said Andy Rothman with CLSA in Shanghai.
He said more symbolic increases in required reserves were likely -- there have already been two this year -- as well as a couple of small interest rate rises in the second half of 2010.
But more dramatic policy steps to ward off asset price bubbles would not be needed, Rothman said in a note to clients.
Xing Ziqiang, an economist at China International Capital Corp in Beijing, said the central bank would wait and see for another month or two before raising interest rates, while Ting Lu with Bank of America Merrill Lynch said he still did not think borrowing costs would rise until the second half the year. (Additional reporting by Zhou Xin and Aileen Wang; Writing by Alan Wheatley; Editing by Ken Wills)