On the consensus interpretation of May figures released today, the Chinese economy retains momentum while inflationary pressures are still rising, warranting a further tightening of monetary policy. The People's Bank, indeed, took the opportunity to announce a further 0.5 percentage point hike in reserve requirements, although this was probably required to sterilise the liquidity impact of continuing foreign reserves accumulation. Industrial output grew by an annual 13.3% in May while CPI inflation rose to 5.5%, the highest since July 2008.

The annual rate of change numbers, however, conceal a recent economic slowdown, consistent with earlier monetary weakness. Industrial output grew by an estimated 5.6% in the six months to May, down from 7.2% in the prior half-year – see first chart. Monetary trends, moreover, have deteriorated further, with real M1 rising by just 1.8% in the latest six months. A similar slowdown in real M1 in mid 2008 preceded a contraction in industrial output.

"True" inflation may be near a peak. Annual M1 growth topped in January 2010 and its maximum historical lead at highs has been 22 months, suggesting an inflation peak by November 2011 at the latest – second chart. The published CPI numbers, however, have been suppressed by price control measures and, possibly, statistical manipulation so could stay elevated for longer, even as underlying inflationary pressures begin to moderate.

The scale of cumulative monetary expansion in recent years coupled with a positive output gap suggest that the authorities must maintain restrictive conditions for a prolonged period for "true" inflation to return to an acceptable level. With monetary trends already signalling a bumpy economic landing later in 2011, however, the consensus recommendation of further policy tightening is questionable.