• Growth in industrial production accelerated more than expected, fuelled by very strong domestic demand in China. It looks increasingly likely that GDP growth will turn doubledigit in late-2009.
  • The Peoples Bank of China will soon have to tighten monetary policy to prevent building the foundation of a new asset bubble.
  • The current China growth story is a strong case for continued CNY appreciation.

Details

Industrial production in May increased 8.9% y/y, which was considerably stronger than expected. However, there has been market speculation in recent days that industrial production figures could come out much stronger than expected

The National Bureau of Statistics (NBS) in China only report industrial production as year-onyear growth figures. The year-on-year-figures really mask the current underlying strength of industrial activity. According to our own calculations, industrial production over the past three months has increased by more than 20% 3M/3M AR. Because industrial production, according to our calculations in line with exports, declined from July 2008 to December 2008, the yearon- year growth in industrial production can be expected to surge in H2 09 and by the end of 2009 growth in industrial production will likely exceed 15% y/y.

The usually close relationship between industrial production and GDP suggest increasing upside risk on our GDP forecast for China (see chart). Industrial production close to 9% y/y indicates GDP growth between 7% y/y and y/y in Q2 (Forecast 7.1% y/y) and industrial production above 15% y/y in late-2009 suggests GDP growth might turn double-digit in Q4 09 and early next year (Forecast: 9.6% y/y).

Today’s retail sales data confirmed that China’s growth is primarily being fuelled by very strong domestic demand

Assessment and outlook

Export May data for China has been very strong and we are fast moving closer to another upward adjustment in our growth forecast for China. Because China has no significant output gap we believe the Peoples Bank of China will probably have to tighten monetary policy early next year, but it is becoming increasingly likely that it could happen even sooner. There is a real danger that the very easy fiscal and monetary policy is starting to build the foundation for the next asset bubble in China.

A modest output-gap and very robust domestic demand in China in our view is a very strong case for believing that at some stage China will resume its gradual appreciation of CNY. China’s trade surplus is declining and by implication its FX accumulation and purchase of treasuries should ease.