Central bank chief hints policy flexibility amid deflation risk(2)

DEFLATION RISK

The protracted economic weakness comes amid subdued price levels, which provided leeway for policy makers to further ease monetary policies, if needed. Central bankers usually follow the inflation and other key economic data to trigger policy easing or tightening moves.

When asked about the implications of China's inflationary change for monetary policy setting, Zhou said "enough attention should be given to inflationary pressure change and a long-term view should be taken."

China's consumer price index (CPI) edged up 1.4 percent year on year in February. The reading quickened from the 0.8 percent gain in January, the lowest level in more than five years, but was lower than the inflation increase target of around 3 percent set for this year.

The CPI is the most important gauge of inflation pressure and the central bank "is closely following" CPI and producer price index (PPI) changes, said central bank vice governor Yi Gang.

Analysts believe this level of inflation is unlikely to be sustained, heightening looming deflationary risk.

The deflation risk is a challenge facing the global economy.

"The People's Bank of China (PBOC) is managing the liquidity when pursuing a prudent monetary policy," said Yi, adding that the combination of a proactive fiscal policy and prudent monetary policy is a good choice.

Some major economies have been stuck in deflation, which will lead to a spiral of ever weaker consumption and growth momentum. Quantitative easing has been adopted by some central banks like the European Central Bank (ECB), and successive interest rate cuts were rolled out in countries such as Australia, Denmark and Canada to tackle deflation and anemic economic growth.

To arrest the economic slowdown and the onset of deflation risks, the PBOC has cut the benchmark interest rates twice and dropped the reserve requirement ratio (RRR) for banks over the past four months. Some analysts believe more easing moves will be needed.

"The deflation risk has put more pressure on the central bank to further cut interest rates and the RRR," the China International Capital Corp., a leading investment bank, said in a report.

Nomura forecast an interest rate cut in the second quarter and three RRR cuts over the course of the year.

When asked whether the recent monetary easing moves had spurred capital flow into the stock market, Zhou warned that some financial market transactions are speculations unrelated to the real economy, but sweeping generalizations should not be made.

"We can not say if there is some capital flowing into the stock market, it is not supporting the real economy, because businesses from many industries are getting financed through the stock market," he added.