CPI inflation surprised on the upside， rebounding to 4.5% y/y in January from 4.1% prior

The Lunar New Year was the main cause， but what comes early also goes early

We call CPI inflation at 3.8% for February; our 2012 CPI inflation forecast is unchanged at 2%

China’s CPI inflation came in at 4.5% y/y in January (Chart 1)， significantly higher than market consensus of 4.0%. The A-share market appears to have focused on the positives suggested by the number (robust consumption and growth resilience)， while playing down the negatives (the number was seen by many as increasing the chances of further delays in policy easing). The lack of a cut in the required reserve ratio (RRR) this year may have already convinced the market that loosening will be slow.

Why did CPI inflation appear to accelerate in January? Based on the m/m， seasonally adjusted annualised rate (SAAR)， the pick-up to 8.72% in January from -1.1% in December was mostly driven by food and services. Food and services prices tend to surge during the Lunar New Year holiday， and then decelerate the following month. Chart 2 shows this holiday-induced ebb and flow in prices for food. The Lunar New Year holidays fell in January in 2009 and 2012， and in February 2008 and 2010. Things were a bit more complicated in 2011， when the holiday fell on 3 February， just after the turn of the month. Services prices peaked in January 2011， as migrant workers usually leave early or demand higher pay to stay as the holiday approaches. Food prices peaked in February 2011 as the food-focused family celebrations kicked in.

Therefore， the y/y CPI inflation number does not smooth out the effect of the holiday， as it moves between January and February each year. January 2012 saw a surge in y/y food inflation (to 10.5%， from 9.1% in December). The impact on services prices was more muted given that in 2011， as noted above， some of the services-related inflation happened in January.

But what comes early also goes early. We believe that China’s January’s inflation was a ?dead cat bounce’， and that February will see a reversal， with CPI inflation – especially for food – falling. Indeed， looking at m/m food price increases during the Lunar New Year month， January 2012 saw the smallest gains since 2006. If the historical pattern holds， food inflation should fall to 8.8% y/y in February from 10.5% y/y in January， and overall CPI inflation should slow to 3.8% y/y.

The National Development and Reform Commission (NDRC) published its view of the CPI figure on its website， arguing (like us) that the uptick was mostly driven by increased New Year demand for food， combined with some bad weather. “Other[i.e.， non-food] prices are basically stable”， it stated. A good grain harvest， a rising pig population since October， and warm weather mean that CPI inflation should fall in February， according to the NDRC. This was a pretty dovish statement.

We maintain our call that CPI inflation will average 2% in 2012， and that there will not be any rate cuts. This is a highly non-consensus call – the market inflation forecast is between 3-4%. In November 2010， we forecast 2011 CPI inflation at 5.5% and predicted four further interest rate hikes. Our inflation forecast was much higher than consensus， but 2011 CPI inflation came in at 5.4%， and we did indeed get four rate hikes.