BEIJING China's annual consumer inflation rate quickened to a seven-month high of 2.5 percent in December on rising food prices, ahead of expectations and narrowing the scope for the central bank to boost the economy by easing monetary policy.
Accelerating inflation adds to signs that the world's second largest economy is finally snapping out of its worst downturn in three years, in a gradual recovery led by strengthening domestic demand.
Analysts say price pressures will quicken in coming months, due to low year-ago comparison figures, but that the inflation outlook remains benign overall, leaving the economy in a sweet spot for now that calls for no change in interest rates.
But should the tentative recovery falter were growth to swoon in Europe and the United States, China's two biggest export markets, Beijing could ease policy by reducing the level of deposits lenders leave with the central bank, economists say.
"There is little pressure from inflation to move on monetary policy," said Alistair Thornton, an economist at IHS in Beijing. "There is room, nonetheless, for a reserve requirement ratio (RRR) cut over the next few months, given potential tightness in the banking system."
For 2012 as a whole, China's consumer inflation accelerated 2.6 percent, comfortably below the central bank's 4 percent target.
"The consumer price index (CPI) data is mainly driven by rising food prices due to seasonal factors and the recent cold weather," said Li Huiyong, an economist at Shenyin & Wanguo Securities in Shanghai.
"We expect consumer inflation would not be a big concern for the government in 2013, with an annual increase of 3 percent."
Zhang Xiaoqiang, vice head of the National Development and Reform Commission, China's top planning agency, was quoted as saying last week that China's consumer inflation would run at 3.5 percent in 2013.
Wary of stoking inflation and stubbornly-high house prices, China has abstained from further interest rate cuts after lowering borrowing costs twice between June and July last year.
It has also refrained from lowering the RRR, the level of cash deposits it requires lenders to hold as reserves, since May 2012, when it reduced the ratio by 50 basis points to 20 percent for China's biggest banks.
Beijing's reluctance to cut rates or RRR after July 2012 contravened widespread market calls for easier policy. Instead, it preferred to loosen policy by adding cash through open market operations, a measure analysts say is more flexible.
And if China's steep home prices should take off again in coming months, defying Beijing's three-year campaign to cool the buoyant property market, some analysts predict the People's Bank of China (PBoC) may even raise rates in the fourth quarter.
A private survey showed house prices in China's 100 biggest cities rose 0.2 percent for the seven consecutive month in December on a monthly basis.
"Should property prices and food prices go higher, the chance of inflation overshooting in the second-half of (2013) cannot be ruled out," said Dongming Xie, an economist at OCBC Bank in Singapore.
"Whether the PBoC will turn hawkish in the second-half will depend on the inflation trajectory."
Home prices are not reflected in China's CPI, which only accounts for residential costs by tracking prices for rents and utilities and the cost of renovating and building homes.
Friday's data showed residential costs rose 3 percent in December from a year ago, the biggest climb since October 2011 and the second-biggest contributor to inflation for the month after food.
SOARING VEGETABLE PRICES
The National Bureau of Statistics, which released Friday's data, said the food inflation, estimated to account for around 30 percent of China's CPI, ran at 4.2 percent year-on-year in December. The non-food component ran at 1.7 percent.
Yu Qiumei, a senior statistician at the National Bureau of Statistics which released Friday's data, said vegetable prices were the key driver of December's inflation jump.
China is experiencing its coldest winter in 28 years and the chilly weather has affected the production and transportation of vegetables, Yu said.
Vegetable prices jumped 17.5 percent in December from November. Of the 0.8 percent month-on-month gain in CPI -- the sharpest in 11 months -- nearly 60 percent came from rising vegetable prices, Yu said.
Data on Thursday showed China's export growth rebounding surprisingly sharply to a seven-month high in December in a strong finish to the year after seven straight quarters of slowdown, even though subdued foreign demand means the revival may not be sustained.
Still, in a sign things may be looking up for China's corporate sector, which has been battling falling profits, Friday's data pointed to easing producer deflation.
The producer price index fell 1.9 percent in December from a year ago in the 10th consecutive month of decline, but improving from November's 2.2 percent annual fall. Economists had forecast a 1.8 percent decline.
"We expect the central bank to keep interest rates on hold, and focus on liquidity management via open market operations, with two to three more RRR cuts throughout 2013," said Zhu Haibin, an economist at JPMorgan.
(Additional reporting by Shao Xiaoyi, Aileen Wang and Lucy Hornby; Editing by Alex Richardson)
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