Despite heightened inflationary pressure on the mainland in August, we think it unlikely that the authorities will take any further action this year. Rising food prices have sparked worries about imminent rate hikes.

The country's Consumer Price Index (CPI) increased 3.5 percent year-on-year in August from 3.3 percent in July, in line with market expectations.

The acceleration of inflation has been primarily driven by food prices as seen by the food CPI, which increased 7.5 percent year-on-year in August compared with 6.8 percent in July.

Food prices have rallied in recent months, driven by price hikes for vegetables, pork and eggs. The agriculture price index was up 5.1 percent in July-August compared with June's figure -- pork and egg prices soared 17 percent during the same period.

However, food prices are expected to stabilize in the fourth quarter of this year. With the end to the "extraordinary" bad weather and with a higher comparable base in the fourth quarter of 2009, vegetable and grain prices in particular are expected to stabilize.

Seasonal patterns support the view that inflation, as it pertains to retail prices, will soften in October and November.

In the past 15 years, figures for month-on-month inflation show that it slowed early in the fourth quarter before picking up again slightly going into the beginning of December. We believe this pattern will hold true this year with food prices stabilizing in September or early in the fourth quarter.

The seasonal pattern of retail prices in the past 10 years also indicates that inflation will moderate in the fourth quarter.

As the year-to-date inflation on the mainland remains at around 2.8 percent, we are confident that the 3 percent full-year inflation target set by the Central Government remains achievable.

In light of the precipitous rise in the CPI, the government is likely to adopt administrative measures to control the inflation of major agricultural products as it has been the key driver of inflation. Grain and vegetables prices have consistently risen more than 10 percent on a year-on-year basis throughout 2010.

However, while the market worries that parallel or asymmetric rate hikes will be introduced in response to the greater inflationary pressure, we don't believe such a move would be able to directly put the brakes on food-price driven inflation.

As inflation remains a key concern for the market with the approach of the holiday season, the consumer sector is likely to continue to outperform other sectors, with department stores expecting a near-term boost to their margins.

Banny Lam is an associate director and economist at CCB International Securities Ltd. The opinions expressed here are entirely his own.

(HK Edition 09/21/2010 page2)