The Chinese economy remained hot in early 2011 but monetary trends are signalling an imminent slowdown.  With the “output gap” positive, however, growth must be held below trend for several quarters to relieve inflationary pressures and allow the monetary authorities to ease off on the brakes. Near term, Chinese equities may face the unappealing combination of earnings downgrades with no monetary loosening.

GDP grew by 9.7% in the first quarter from a year before and by 2.1%, or 8.8% annualised, from the fourth quarter of 2010. Domestic demand was up by 10.2% from a year ago but trade subtracted 0.5 percentage points from GDP growth as imports boomed – consistent with the economy "overheating".

The first chart shows six-month growth of industrial output and real money. Recent output buoyancy reflects both stronger global demand and a mini-revival in monetary expansion during the second half of last year. Policy tightening and higher inflation, however, have caused real money trends to weaken in early 2011. With global momentum peaking, the economy could slow sharply over coming months.

Will slower growth bring early inflation relief, heading off further monetary policy tightening? Probably not. The scale of monetary excess over 2008-10 and an associated positive "output gap" – second chart – suggest that inflationary pressures will remain strong for some time after the economy starts to cool. Today's inflation news was poor, with headline and non-food CPI inflation rising to 5.4% and 2.7% respectively in March and the more realistic GDP deflator climbing by an annual 7.6% in the first quarter – third chart.