China's August CPI Surges, Rate Hike Looks Imminent

China's inflation surged in August to the highest level in a more than a decade as meat and vegetable prices skyrocketed, putting the central bank on track to raise interest rates again soon as government efforts to curb food prices fail.

Accelerating for the fourth straight month, China's consumer price index climbed 6.5% in August from a year earlier, the government said Tuesday, marking the biggest jump since December 1996 and well above the 6% increase that markets were expecting. For the first eight months of this year, CPI was up 3.9% on year, well above the government's targeted full-year ceiling of 3%. "We expect the central bank to respond to higher inflationary pressures with decisive tightening measures, including two interest-rate hikes to the benchmark lending and deposit rates by the end of this year," Goldman Sachs analysts said in a note to investors. Tim Condon at ING predicted a 27 basis-point deposit-rate hike before an Oct. 1 national holiday. "Six percent is really a focal-point number," he said. "The authorities don't want to be perceived as being asleep at the switch." Last month the People's Bank of China raised one-year lending rates by 18 basis points and the one-year deposit rate by 27 basis points - a week after July CPI hit a then-decade high of 5.6%. Expectations for a fifth rate hike of the year have been growing. PBOC Gov. Zhou Xiaochuan said this week he's concerned about inflation, and central bank officials have acknowledged 2007 inflation may exceed the government target. The central bank Thursday raised banks' reserve requirements, but inflation and runaway growth show no signs of slowing. JP Morgan Tuesday raised its full-year China inflation forecast to 4.1% from 3.8% and its 2008 prediction to 3.5% from 3.3% previously. Food prices, which make up just over a third of CPI, jumped 18.2% in August, accelerating from July's 15.4% gain, according to the National Bureau of Statistics. Meat and poultry price rises accelerated to 49% on year from July's 45% increase, fresh vegetables rose 23% in August vs July's 19% and grain prices were up 6.4% in August, picking up from July's 6% gain. Food prices has been surging in large part on sky-high pork prices due to outbreak of a deadly pig disease that has shrunk supplies of pork, while flooding has raised vegetable prices. Nonfood prices rose a moderate 0.9% in August, unchanged from July's increase. But government officials have said unless food prices can be brought under control, overall inflation can't be meaningfully brought down. Yet rate hikes are ill-suited to address shortages, such as those seen in pork, said Lehman Brothers economist Robert Subbaraman. And upward pressure on has started to emerge on producer prices, which picked up in August after a three-month slowdown. China's inflation is feeding through to rampant rises in the nation's stock market, as consumer prices surge above deposit rates, giving savers little incentive to keep their cash in the bank when they can plow it into shares. Savers are effectively looking at a nearly 3% negative return for keeping their money in one-year bank deposits, while lending rates imply the cost to borrow money remains fairly cheap. The Shanghai Composite index, which has almost doubled so far this year, was down 0.3% to 5341.23 around midday Tuesday. Government bonds were also lower on the surge in prices and on news of a looming bond sale by the Finance Ministry.