Turnaround Gains Momentum

China's annual consumer inflation jumped to 3.2 percent year on year in February, up from 2 percent in January, for the highest increase since April of last year (see Chart 1). The latest reading highlights the difficulties in keeping the economy growing at a steady pace while avoiding steep rises in prices. Prices were likely boosted by the Lunar New Year holiday (the Spring Festival), which often brings a spike in prices for food and other goods. The Chinese Government has set an inflation target of 3.5 percent, lower than 2012's target of 4.0 percent and raising expectations that monetary policy will tighten in the near future. Meanwhile, prices at China's factory gates prices remained unchanged, as the Producer Price Index (PPI) held steady at 1.6 percent in February, reflecting the mild nature of the recovery (see Chart 2).

Manufacturing continues expansion

China's official Purchasing Managers' Index (PMI) for the manufacturing sector fell for a second month to 50.1 in February from 50.4 in January (see Chart 3). A reading above 50 indicates an expansion in manufacturing activity while a reading below 50 indicates contraction. While the drop was caused by February's week-long Spring Festival holiday, the PMI stayed above 50 percent for the fifth consecutive month, indicating continued expansion. The latest reading revealed China's industrial production remains steady while Chinese companies are relatively optimistic about their future economic prospects. China's ongoing recovery remains uneven, with large companies continuing to have a more favorable outlook on the economy than SMEs.

Exports remain strong

Other indicators of economic activity softened in the first two months of the year. Retail sales were up 12.3 percent year on year in January and February, compared with a 15.2-percent rise in December (see Chart 4). Chinese trade data underlined the uneven path of the recovery, as exports soared past forecasts, while imports were surprisingly weak, falling at their fastest pace in over a year. Overall, China's trade surplus narrowed to $15.2 billion in February from a month earlier, a good sign given most analysts were expecting a trade deficit for the month. Imports shrank by 15.7 percent at $124.1 billion (see Chart 5) while exports rose a stronger-than-expected 21.8 percent to reach $139.3 billion (see Chart 6). The latest export figure provided a promising signal for the level of global demand, with exports to the United States up 15.7 percent from a year earlier and exports to the EU up 16.5 percent.

Mild recovery

An economic recovery that started in the fourth quarter last year is now being viewed as a mild one engineered to ensure stability during the first year of a new government headed by Xi Jinping and Li Keqiang, who formally took over the reins in March. While this pickup, largely led by exporters, should have enough momentum to stabilize growth in the first half of 2013, import growth has lagged behind exports, undermining efforts to increase domestic demand as a new source of economic growth. The National Development and Reform Commission, the country's economic planning agency, has set a target of 8 percent growth in trade for 2013 after the country missed its 10 percent goal in 2012 due to weak demand from Europe, its second-largest market.