Reassuringly soft

China: China’s latest data shows inflation is still a threat — but investors have their minds on other things. While consumer prices increased at their fastest pace in 34 months in May, stable growth in investment and production are evidence China has not tightened too hard. That has given the market hope that a soft landing may be in store for the world’s second-biggest economy.

China’s May inflation was stronger than expected. The consumer price index rose by 5.5 per cent year-on-year in May, or 5.7 per cent on a seasonally adjusted, month-on-month basis, according to Goldman Sachs. The central bank promptly raised lenders required reserves for the sixth time this year, but with one-year real interest rates remaining deeply negative at 2.25 per cent, more policy tweaks are needed.

But growth still looks healthy. China's industrial production grew strongly by 13.3 per cent year-on-year, down slightly from 13.4 per cent in April. Fixed asset investment rose by 26 per cent in May, a slight increase from April and exceeded average estimates. Retail sales grew robustly by 16.9 per cent over last April. Investors breathed a sigh of relief.

Equities could benefit from renewed optimism. Shanghai is the second-worst performing big global market after Athens, down 7 per cent, as investors have worried that inflation measures might hurt investment and consumption. Although production by heavy industries moderately decelerated in May, growth of light industries rebounded. Inflation concerns even prompted consumers to spend 43 per cent more on jewellery in May than a year ago.

With gradual tightening, inflationary pressures may ease. Broad money growth fell below the 16 per cent official target for the second month in May. The narrowing trade deficit means there should be less money coming into China from purchases of exports.

This sets the scene for more yuan appreciation. Authorities should now be more willing to let the currency strengthen to combat imported inflation, without worrying that growth might suffer as a result. That may explain why the yuan rose against the dollar both in the spot and offshore forward market on June 14. For now, inflation risk is something global investors can live with.