The Chinese authorities have been attempting to tighten monetary policy without raising interest rates or allowing the exchange rate to appreciate. The latest inflation and monetary statistics suggest that their efforts are failing.

Consumer prices rose by 2.8% in the year to April and at a seasonally-adjusted annualised rate of 3.9% over the last three months – see first chart. If this latter rate of increase is maintained, annual inflation will reach 4.0% in August and average 3.2% in 2010, above the 3% target – green line in chart.

Momentum, however, is likely to accelerate further. Chinese inflation follows swings in narrow money, M1, growth – second chart. The annual M1 increase reached a 17-year high of 39% in January and was still 31% in April. Shorter-term growth also remains buoyant – 30% annualised over the last six months. Historically, these rates of expansion have been associated with 20%-plus inflation.

Administrative controls and "moral suasion" have resulted in a more significant slowdown in credit and broad money, M2. Six-month growth rates, however, remain solid, at 18% and 19% annualised respectively. The demand to hold M2, moreover, has probably fallen as inflation has moved above deposit rates. M1 is a measure of transactions rather than savings money and should be a better leading indicator of activity and price pressures.

The prospect of more significant Chinese policy tightening is a further reason for caution about the liquidity backdrop for markets.