China deflation pressures persist to ease gradually: HSBC

Inflation rises to 1.9% in September.

September CPI inflation surprised the market on the upside, coming in at 1.9% y-o-y, up from 1.3%.

Out of the 0.6ppt increase, HSBC estimates that 0.4ppt can be attributed to fast-rising fruit and vegetable prices in regions affected by typhoons and other adverse weather conditions.

The rest of the 0.2ppt, it said, came from increase in energy prices (0.1ppt), and increase in the price of services such as education and travel.

"Although services sector prices are to some extend regulated, the more broad-based improvement this month suggest that underlying demand is likely also improving," it said.

HSBC added that although property prices have been rising at a fast pace in Tier 1 and select Tier 2 cities, historically price changes in this part of the economy have not been well represented in the CPI basket. In fact, residence price inflation remained unchanged at 1.5% y-o-y in September.

Meanwhile, PPI inflation turned positive for the first time since March 2012, ending 54 consecutive months of contraction.

"As we have noted before, producer prices have been improving sequentially since the beginning of the year in a sign of easing deflationary pressures in the industrial sector," said HSBC.

While fiscal expansion (and to some extent the property sector rebound) has helped to anchor demand, the government has also been making a bigger push to reduce capacities (although progress remains uneven across different sectors), it added.

In recent months, the impact of domestic adjustment has been reinforced by higher commodity prices, particularly oil price, in the international market.

Therefore, although PPI inflation has turned positive a little earlier than expected, this does not come as a surprise, said HSBC.

Further improvement in prices will depend on continued fiscal expansion and supply side adjustment in the coming months.

According to HSBC, today's data suggest that deflation pressures continue to ease gradually in the Chinese economy. This, it said, has come on the back of stronger demand (due to faster infrastructure investment, and property sector rebound), as well as supply adjustment in the industrial sector.

"While the pace of the improvement is faster than expected in September, there are still risks on the horizon in the next few months. On the demand side, although fiscal expansion has helped to stabilise growth, the multiplier effect, in terms of lifting private sector investment, appears to be quite limited so far," it said.

According to HSBC, reviving private sector business investment remains a key policy challenge in the near term.

Export outlook also appears quite challenging, with the latest export data in September showing a return to double-digit contraction

In recent days, policy makers are also making a more concerted effort to manage the property market cycle, with the aim of trying to limit the pace of price gains in Tier 1 and select Tier 2 cities.

"Some in the market are worried about downside risks to growth if these measures have their intended effect. We are not as worried, although the impact on sentiment is harder to predict," said HSBC.

Given lingering headwinds to growth, policy makers should retain their easing bias in the near term, it said.

"We have pared back our calls for further monetary easing, but expect monetary conditions to remain accommodative. Fiscal policy is expected to remain expansionary with a greater focus on policies that will have bigger multiplier effect in terms of lifting private sector confidence and investment,"