By Sue-Lin Wong and Min Zhang
BEIJING (Reuters) - China's factory price inflation held steady in July in a positive sign for industrial output and profits for the third quarter, even though a government-led drive to reduce debt is expected to cool earnings and economic growth by year-end.
China's economy has expanded solidly this year as commodity prices recovered, helping boost the industrial sector, while mild consumer price gains have left policymakers room to maneuver should growth falter.
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The producer price index (PPI) rose 5.5 percent last month from a year earlier, unchanged from June, the National Bureau of Statistics (NBS) said on Wednesday. Analysts polled by Reuters had expected producer prices to hold steady for a third straight month at 5.5 percent.
Analysts say given expectations of deeper capacity cuts heading into the winter months, keeping supply tight and prices up, operating margins for businesses will probably remain solid in a boost to the bottom line.
"We expect the PPI y/y to remain strong in the coming months, as the capacity reduction proceeds," said David Qu, markets economist at ANZ in a note to clients.
"The strong PPI indicates decent growth in corporate profits, especially for SOEs, leaving the authorities room for deleveraging," he said.
On a month-on-month basis, the PPI rose 0.2 percent in July, after three months in the red, with the NBS attributing this to a rise in prices of commodities including steel and non-ferrous metals.
Prices of commodities futures including steel rebar began to rise again in June and have continued to surge through early August, underscoring concerns over tight supply amid pollution inspections and strong restocking demand.
China has eliminated around 120 million tonnes of low-grade steel capacity and 42.39 million tonnes of crude steel capacity in the first half of the year, equivalent to 84 percent of its target for the whole year.
Beijing has also ordered steel and aluminum producers in 28 cities to slash output during the winter heating season that starts in November to curb pollution, spurring local investors to anticipate gains for big producers when a shortfall bites.
Besides the capacity cuts, "the strong pipeline of infrastructure investment will continue to underpin material prices in the coming months," ANZ's Qu said.
Shares in state-run Aluminium Corp of China (Chalco) have surged 63 percent since the start of July, while shares in Shenzhen-listed Yunnan Aluminium have rallied 67 percent.
Inflation has been sluggish in major economies including the United States, Europe and Japan despite brightening growth.
China's consumer price index slowed slightly to 1.4 percent in July from a year earlier, missing market expectations, pressured by a 1.1 percent annual fall in food prices. Analysts had predicted consumer inflation to have remained unchanged at 1.5 percent for the third month in a row.
"The current level of consumer inflation is so mild that the PBOC will be comfortable resuming the deleveraging process in the financial sector," Iris Pang, ING economist wrote in a note ahead of the data.
Chinese policymakers have clamped down on expansion of the money supply, and broad credit growth has also moderated, which could weigh on any further industrial recovery in China.
The world's second-largest economy has defied expectations for a slowdown and expanded at a solid pace in the first half, as a government-led infrastructure push has kept construction humming, though the broad consensus is for growth to cool slightly in coming quarters as authorities continue to crackdown on financial risks.
Any weakness in factory price inflation could start to weigh on profits at China's large - and often heavily indebted - industrial firms, who have benefited from a strong commodities reflation cycle over the last year.
While China's manufacturing sector has shown solid activity, a potential slowdown in profit growth would impact their ability to trim debt levels, which remain a concern for policy makers.
"We expect the central bank to keep liquidity either as tight as in July or even slightly tighter, and push interbank interest rates higher, especially at the short-end to reduce leveraging activities by interbank participants, which include banks and non-bank financial institutions," ING's Pang said.
China has set its inflation target at 3 percent and economic growth of around 6.5 this year, which suggests policy makers still have room to tighten controls to rein in financial risks from years of debt-fueled stimulus.
(Reporting by Sue-Lin Wong and Min Zhang; Editing by Shri Navaratnam)