Don't fear China inflation after fuel price rise

By Simon Rabinovitch and Eadie Chen - Analysis

BEIJING (Reuters) - China's surprise increase in fuel prices will not undermine the country's fight against inflation. On the contrary, it reflects confidence that overall price pressures can be contained.

The unpleasant news for motorists on Thursday that their bill at the pumps was going up overnight by as much as 18 percent prompted consternation and anger about the rising cost of living in China.

Economists, however, took the announcement with far greater sangfroid.

Higher resource prices will undoubtedly feed into inflation, but in a nation where consumers spend little on fuel products, the impact will be relatively small. Most economists expect that an extra percentage point, or even less, will be added to consumer inflation over the rest of the year.

Food prices, the dominant source of inflationary pressure in China over the past year, have dipped over the past two months, allowing headline inflation to slow to 7.7 percent in May from 8.5 percent in April.

"That is a significant decline and that also gave them a window of opportunity to make the price hike," said Qing Wang, Morgan Stanley's chief China economist.

There are, however, clear risks in the sudden policy change.

Though consumer inflation has retreated somewhat, it is still within striking distance of 12-year highs.

And while shoppers have seen prices come down, offices and factories have faced a steady increase in the cost of inputs. Producer price inflation reached 8.2 percent in May, the highest in nearly four years.

The heftier bill for fuel and power will add to these pipeline pressures, Zhao Qingming, chief economist at China Construction Bank, said.

But while manufacturers may find their margins squeezed, the pass-through to consumers will be muted.

"I think now is a good time for this. It won't have a big impact on consumer prices," Zhao said.

Refined oil has a weight of just around 0.5 percent in the consumer price index, Goldman Sachs says. Food accounts for a third of the CPI basket.

ADJUSTMENTS

And motorists burdened by the jump in fuel costs will simply spend less on restaurant meals, karaoke outings, jewelry or what have you. So while relative prices fluctuate, headline inflation will not be nearly so volatile.