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China posts benign consumer inflation in July, but producer deflation stays stubborn

By Pete Sweeney

SHANGHAI (Reuters) - China posted mild consumer inflation on Saturday, well below the annual target in July, giving authorities room to further relax monetary policy, but deflationary pressure for producers remained stubborn, highlighting a wobbly economic rebound.

Data from the National Bureau of Statistics (NBS) showed that the consumer price index (CPI) held steady at 2.3 percent year-on-year in July, while the producer price index (PPI) fell 0.9 percent for the 29th consecutive month.

Both indicators matched analyst forecasts.

Analysts attributed the steady CPI to slides in pric4es for fresh fruit and vegetables, which offset rises in other categories.

"In general, China's inflation outlook remains mild; however, the deflation risks may even rise in the foreseeable future if the growth momentum weakens again," ANZ economists Liu Li-Gang and Zhou Hao said in a research note, reacting to the data.

"Against this backdrop, the central bank should maintain an accommodative bias in the monetary policy stance."

Ma Zihui, researcher at Huarong Securities in Beijing, said the slide in the PPI was "not a good message".

"July macroeconomic data might come out worse than some people expected," he said.

The NBS said on its website that the slowing pace of declines in PPI in recent months - after plummeting a startling 2.3 percent in March - suggested a nascent recovery in industrial demand could be getting underway.

ROOM TO MANEUVER

Consistently mild inflation in 2014 has given the government considerable leeway to ease up on liquidity taps, and it has experimented with a variety of measures intended to support growth without reinflating asset bubbles.

But economists are divided as to how effective efforts have been. While exports and manufacturing activity produced positive surprises in July, import and services data suggest fundamental domestic demand remains subdued.

"The PPI year-on-year decline narrowed thanks to stabilization policies supporting economic recovery," said Li Huiyong, macroeconomic analyst at Shenyin Wanguo.

"But it should be noted that industrial overcapacity has not been completely digested, it's only been phased out of the market; as consumer prices recover, more production capacity will be gradually released, so I'm not optimistic about a rebound in PPI."

The central government has been struggling to convince recalcitrant local governments to shut down excess capacity in bloated industries like steel, shipbuilding, cement and glass, but to the frustration of regulators it appears the latter two industries are actually trying to add fresh capacity in 2014.

PRECISION FIREPOWER

Regulators have hoped that a cocktail of targeted stimulative ingredients, such as targeted RRR cuts at rural banks, judicious short-term injections into the money market and tweaks to rules governing loan-to-deposit ratios, will ultimately juice investment in the real economy and, by extension, consumer demand.

These initiatives have the advantage of being both flexible and easily reversible, unlike a cut to bank reserve requirement ratios (RRR), which would pour long-term cash into the base money supply.

Some economists have called for the government to cut RRR nevertheless, but the People's Bank of China (PBOC) has remained wary of introducing more money into the economy than it can comfortably digest, as occurred in 2008 and 2011, when consumer inflation skyrocketed to widespread social dissatisfaction.

Others have said PBOC cut to benchmark interest rates would be more likely and less drastic than an RRR cut, and the rate of the interest rate swap based on the 1-year deposit rate has declined steadily since Dec 2013, suggesting markets are increasingly pricing in the likelihood of a cut.

While recent efforts to get more cash into the system do appear to have produced a recovery in bank lending in recent months, economists expressed concern that much of the credit created appeared short-term in nature, suggesting it was being used primarily by companies to stay afloat or to roll over existing debt, instead of investing in new projects.

The easy liquidity is also credited with supporting a recent rally in China's major stock indexes, although analysts say signs of relaxed curbs in property markets are also supporting the rally.

(Additional reporting by Tina Qiao and Koh Gui Qing in BEIJING; Editing by Jeremy Laurence)

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