China inflation drops to 1.9%

But the economy must brace for CPI inflation increase in the fourth quarter.

According to Nomura, CPI inflation dropped marginally to 1.9% in September from 2.0% in August, consistent with market expectation.

Here's more from Nomura:

Inflation rose by 0.3% month-on-month, slightly lower than the historical average of 0.4% since 2001, which is largely due to a slower-than-average rise in food prices (0.2% in September 2012 vs. historical average of 0.8%).

We maintain our view that CPI inflation bottomed in July and will rise in Q4. Food prices will likely rise due to seasonally strong demand. If growth recovers, as we expect, it will further exert upward pressure on non-food inflation as well.

PPI inflation dropped by 3.6% in September, broadly in line with market expectations. The pace of PPI deflation slowed, as it fell by only 0.1% m-o-m from an average decline of 0.6% m-o-m over each of the four previous months. We believe PPI inflation will soon bottom due to the rebound in global commodity prices and our expectation for a domestic economic recovery in Q4.

Regarding policy, we believe the PBoC remains concerned with the inflation outlook and will keep interest rates unchanged for the remainder of 2012.

At the IMF annual meeting in Tokyo, PBoC Deputy Governor Yi Gang indicated that the central bank‟s top priority was controlling inflation. The recent recovery in the housing market and the rebound of housing prices also reduces the space available for rate cuts.

We continue to expect inflation to rebound faster and stronger than consensus in 2013, climbing to above 4% in Q2 which should pressure the PBoC to hike interest rates in H2 2013.

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