Eco Analysis - The Chinese economy is undoubtedly heating up (W. Yao)

Eco Analysis - The Chinese economy is undoubtedly heating up (W. Yao) ■ Inflation advanced but less than expected China's consumer price inflation came in slightly below expectations at 2.0%yoy in November (Cons. & SG 2.1%), up from 1.7%yoy in October. The 0.4ppt increase was a result of a 1.2pp increase in food inflation to 3.0%yoy. Within the non-food components, housing inflation moved up marginally to 2.6%yoy from 2.5%yoy, while other categories unexpectedly softened to 1.2%yoy from 1.4%yoy, according to our calculation. The seemingly big jump in food inflation was in large parts due to a base effect. The mom gain was 0.3%, reversing less than half of the 0.8%mom decline in the previous month. The return of food inflation has been gradual, especially given the sharp rise in global food commodity prices during the summer. Producer price inflation (PPI) also moved up to -2.2% in November from -2.8%yoy in October, less than market expectations (Cons. -1.9%yoy) but in line with ours. In mom terms, PPI actually declined by 0.1% in November, after only one month of positive readings. The resumption of deflationary pressure is in line with the latest input price index in the official manufacturing PMI report, which stopped rising and fell to 50.1 in November. Still-high inventory levels and excess capacity in a number of industries are likely to put persistent downward pressure on upstream producer prices and corporate margins. Looking ahead, we expect both CPI and PPI to continue moving up, thanks to base effects. However, underlying inflationary pressure is likely to remain soft, especially on the PPI. ■ Industrial production and retail sales again delivered sizable positive surprises China's industrial production (IP) growth rose to the fastest pace since April 2012 of 10.1%yoy in November, comfortably beating expectations (Cons. & SG 9.8%) for a third month in a row. The base effect helped, as, in 2011, IP growth declined by 0.8ppt from October to November. The mom increase also accelerated from 0.83% in the previous month to 0.86% - the strongest in six months. Excluding the base effect, textile, chemical and machinery manufacturing improved the most, while the non-ferrous metal and transport equipment manufacturing sector decelerated further. Electricity production - an indicator of general activity strength - rose 7.9%yoy in November, up from 6.5%yoy in October and merely 2.1%yoy in Q3. Fixed asset investment (FAI) data was less upbeat, with year-to-date growth moderately below expectations at 20.7%yoy (Cons. 20.8%, SG 20.9%). This year-to-date rate implied a decline in monthly yoy growth from 22.2% in October to 20.7% in November, despite a weaker base last year. The momentum of infrastructure FAI softened somewhat, compared to the previous two months, while manufacturing FAI growth was largely flat. However, the housing sector was a bright spot. Residential investment growth accelerated substantially to 21.8%yoy in November from 13.2%yoy in October. Housing sales resumed the upward trend of this early summer, rising 43.1%yoy in value terms and 31.6% in volume terms, which points to further improvement in housing investment and construction in coming months. Lastly, retail sales delivered big positive surprises once again, growing 14.9%yoy in nominal terms and 13.6%yoy in real terms in November. Interestingly, the largest gain was recorded in jewellery sales, which rose by 20.8%yoy, compared with 10.3%yoy in the previous month. Together with the robust housing sales, it seems Chinese households continue to have an unambiguous preference for physical assets when it comes to their asset allocation. Overall, the latest activity data was quite positive, which puts upward pressure on our current growth forecast of 7.7%yoy for Q4. The Chinese economy is undoubtedly heating up. Policymakers will meet at the Central Economic Work Conference (CEWC) in the next few days and set the economic targets for 2013. At the Politburo meeting last week - the prep meeting for the CEWC, the top leaders sounded more confidence in the growth momentum, reiterated to maintain prudent monetary policy, and emphasised the importance of the quality of growth as well as structural reforms. Hence, we expect no change in either the growth target of 7.5% or the cautiously supportive policy stance.