2 inflation woes China investors must hurdle

Even amid 7.8% GDP growth.

Activity data came out quite strong according to analysts of Bank of America Meryll Lynch, with the print of 10.1% industrial production (IP) growth in November, supporting the view of rebounding GDP growth in the country. 

Here's more from BofAML:

We are confident to maintain our 7.8% yoy GDP growth forecast for 4Q12 (vs 7.4% in 3Q). Meanwhile, the low inflation means that there is no need to worry about any policy reversal in the near term.

We expect Beijing will sustain the current policy stance which could be featured as marginally pro-growth without big-bang stimulus. More specifically, we expect no rate and RRR cut before end-2012. With rebounding GDP growth, rebounding earning growth and low inflation, we think the Chinese economy is now in a sweet spot and can stay in it through 1H13.

It should bolster asset prices from equities to commodities. Surely the RMB will also be supported, though the PBoC may intervene to cap the rising momentum. That said, we warn the need for precaution as growth could moderate and inflation may pick up in 2H13. By mid-2013 there may be more worries about side-effects of policy easing such as government debt and shadow banking.

Street economists have been revising up their GDP growth forecasts of 2012 and 2013. Our once out-of-consensus view of higher GDP growth in 1H13 (8.3% yoy) and moderation in 2H13 (to 8.0% yoy) has gained recognitions based on client feedbacks.

Manufacturers’ earning growth will benefit from the negative PPI inflation this year. The positive impact on profit margin could be especially salient in coming months as manufacturers use inventories purchased at lower prices previously.

NBS data showed that earning growth of manufacturers has already risen from the negative territory to 7.7% yoy in Sep and 21.5% in October. Though current low inflation is definitely good for growth and markets, investors should be concerned about an inflation rebound to above-trend levels in 2H13.

First, low prices now mean low comparison base later, so year-on-year inflation could surprise on the upside in 2H13; and second, crashing prices of vegetable and pork may discourage farmers’ planting and thus reduce supply in 2013.