Wen Jiabao declares inflation victory - wishful thinking?

China's premier Wen Jiabao declared in an FT editorial that China is winning the fight against inflation. This is wishful thinking. China has made as a strong effort to tighten monetary policy after a surge in liquidity in response to the financial crisis. Reserve requirements and rates have been increased on a steady basis, but inflation has still been rising. The explosion of liquidity allowed growth to be renewed but also caused an increase in speculation and a general increase in inflation. Any cutback in liquidity takes time and China does not want to slow growth below 8 percent.

Any peaking in inflation may have more to do with the slowing of commodity prices. Now the commodity price increases have been tied to China growth, but there is still high demand for better food and energy. This commodity demand is associated with the overall size of the China economy and not just the growth rate. Hence, there will still be price pressure on commodity prices even if there is a slowdown in growth and less liquidity.

Many have declared triumph over inflation only to see it continue. Breaking inflation is never easy and prices have a tendency to move in their own direction. There is still a lot of liquidity in the Chinese economy so it may be premature to announce victory on the inflation war.