China December inflation edges up as expected, producer prices still in deflation

China's consumer inflation barely edged up in December while companies' factory-gate prices continued to fall, adding to concerns about growing deflation risks in the world's second-largest economy.

In line with sluggish activity, China's consumer inflation quickened slightly to 1.6% year-on-year in December, as expected, compared with 1.5% the previous month.

The producer price index was unchanged at minus 5.9% in December, the National Bureau of Statistics said on Saturday, slightly above forecasts but marking a 46th straight month of declines and highlighting the deeply entrenched pressures facing China's manufacturers as the economy cools.

"The inflation profile remains soft and the continuous PPI deflation suggests that Chinese companies will have to reduce their debt as further expansion in many industries will only lead to more loss," wrote Zhou Hao, economist at Commerzbank in Singapore.

An official survey last week showed China's manufacturing sector contracted for a fifth straight month in December and factories continued to shed jobs, dampening hopes that the economy will enter 2016 on steadier footing.

China Beige Book International (CBB) said in its latest private survey that growth in input prices and sales prices for Chinese firms slipped to record lows in the fourth quarter.

"For the first time, it looked like firms were encountering genuinely harmful deflation," the private survey said. That opinion was echoed by other economists.

The risk of entrenched deflation is a nightmare for China, which desperately wants to avoid becoming stuck in a trap where falling prices sap economic vitality.

Deflationary cycles encourage consumers to hold off from buying and businesses to hold off from investing indefinitely, on expectations that prices will continue falling.

Such cycles can prove extremely difficult to escape, and Chinese policy makers have kept a worried eye on the example of Japan, where a strong currency, distorted banking sector and muddled monetary policy combined to suppress growth for decades.

Fighting Deflation With Currencies

Given how stubborn deflationary pressure has proven in China, regulators appear to be bringing the exchange rate to bear on the problem. After spending most of 2014 holding the yuan steady while other currencies dropped against the dollar, Beijing since August has let its currency fall more than 6% against the dollar, to its weakest level since 2011.

A weaker yuan could help to fight deflation imported via sliding commodity prices, while providing some support to the struggling export sector and allowing the central bank to stop drawing down its foreign exchange reserves to hold the yuan firm against the dollar.

That would also indirectly support efforts to lower onshore borrowing rates for debt-laden Chinese firms, although it would make the cost of servicing their offshore debt far more expensive. In response, it appears that Chinese corporations with dollar-denominated debt are hurrying to pay it down before the yuan weakens further.

A rising chorus of policy advisers and industrial constituencies is lobbying for an even deeper devaluation to the currency, by as much as 10 to 15%, despite the risk of a potential currency war of competing devaluations in Asia.

China's consumer price index is likely to climb 1.7% in 2016 from last year while its producer price index is forecast to fall 1.8% year-on-year, the central bank said in a working paper last month.

China is set to release fourth-quarter and full-year GDP data on January 19.