China inflation pegged to drop to 2.4% in March

Here's why it can shoo away inflation fears.

According to Bank of America Merrill Lynch, China's stock markets recently took a hit due partially to renewed worries on inflation, but it believes the markets' fears on surging inflation and monetary tightening are overdone. It expects CPI inflation to fall to 2.4% yoy in March from 3.2% in Feb.

Here's more:

Headline yoy CPI inflation could remain below 3.0% before mid-year. Due mainly to slumping vegetable prices in Sep-Nov 2012, yoy CPI inflation could rise to above 3.0% in Sep-Nov, but we think the chance for it to exceed 4.0% is quite small. Why are inflation fears overdone?

First, headline yoy CPI inflation jumped to 3.2% in Feb from 2.0% on Lunar New Year holiday distortion. Second, hundreds of dead pigs floating in the upstream of Shanghai's Huangpu River made people wonder if a coming shortage of pork supply could lead to surging inflation.

Finally, the rapid rise in home prices (up about 1% mom in Jan and Feb) made people wonder if high money supply growth in 2009-10 could result in runaway CPI inflation sooner or later.

China's 190% M2 to GDP ratio is the focus of recent hot debates, forcing the People's Bank of China (PBoC) to clarify that the M2/GDP ratio has no strong implications for inflation.

We will write a separate report on the M2/GDP ratio which is much more academic; in this report we will just focus on pork supply, the LNY distortion, the weaker-than-expected GDP growth momentum and global raw material prices.

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