ChinaÆs worst snowstorm of the century could hurt its inflation much worse than initially expected, and this could pressure Beijing to ease up on credit tightening measures.

According to Morgan Stanley, ChinaÆs producer price inflation rose to 6.1% in January, and this factors in the impact of the snowstorm. Wang Qing, Morgan StanleyÆs chief economist for the Greater China region, says the inflation increase is within the bankÆs expectation as existing supply bottlenecks for energy and food were worsened by transportation disruptions last month.

Jun Ma, chief China economist at Deutsche Bank, says further pressure on inflation is likely to continue for the rest of this quarter. Expectation, rather than actual supply and demand, is now the key reason why inflation is rising, he says, noting the cycle reinforces existing price pressures and creating a far stronger ôspiral effectö.

Amidst rising inflation, Ma expects Chinese policymakers to reverse their credit tightening policies. Opposition to tightening measures have been mounting in the government, even as the growth in M2 broad money is now at its highest in eight months at 18.9% year-on-year. Ma says bank leaders are now complaining that liquidity has become excessively tight, after the recent snowstorm.

One of the more important measures developed by the Chinese government to combat inflation was the qualified domestic institutional investor (QDII) scheme -- which worked by siphoning off liquidity. But Shanghai-based research company Z-Ben Advisors notes that the QDII scheme is now at a standstill, as reflected by ICBC Credit SuisseÆs recent QDII launch. The fund raised just Rmb4 billion ($557.9 million), falling short of the Rmb22 billion ($3.1 billion) quota approved for the fund. Previous QDII launches were sharply oversubscribed.

Z-Ben Advisors says bleak months lie ahead for offshore fund launches because other funds, such as China International, China Southern, Harvest and China Asset Management, have failed to meet investor expectations. Investor confidence might have been dampened by the global sell-off and poor performance in the Hong Kong equity market, in which QDII portfolios are heavily invested.

Meanwhile, Morgan StanleyÆs Wang says the recent string of aggressive rate cuts by the US Federal Reserve will leave the Chinese policymakers with less room to manoeuvre. He believes no rate hike will be imposed in China this year. Instead, policymakers are most likely to speed up renminbi appreciation, and the PeopleÆs Bank of China will likely raise the reserve requirement ratio to slow down monetary growth.

Ma has cut his 2008 growth forecast for China from a previous 10.4% to 10%, factoring in the snowstorm and an export slowdown this year.