Consumer prices in China fell for the first time in more than six years last month, sending the world’s third-largest economy into technical deflation as officials described the outlook as grim.

However, several analysts said that China may be able to avoid falling into a debilitating deflationary spiral that would sap growth as falling prices hit profits and increased debt burdens, prompting companies to slash jobs, wages and investment.

The consumer prices index (CPI), China’s main inflation benchmark, fell by 1.6 per cent in the year to February, giving the central bank plenty of room to cut interest rates yet further, if needed, to boost the economy.

A 1.9 per cent decline in food prices, a big component of the index, and slides in international commodity prices helped to drag the index down.

So did excess inventories for many industries.

The CPI's first fall since December 2002 suggests that China can afford to cut interest rates further to help to spur economic growth without reigniting inflation, which hit a high of 8.7 per cent last year.

However, analysts said that technical factors were the main reason for the decline.

Mingchun Sun, of Nomura Securities in Hong Kong, said that the lapse into deflation was likely to be temporary.

Inflation would return by the second half of the year and reach 2.8 per cent in the fourth quarter, he said. For all of 2009 the CPI was likely to rise 0.6 per cent.

"Considering the inflationary nature of the stimulus package, we believe the People's Bank of China will hesitate in cutting rates," Mr Sun said in a report.

"Therefore, we now expect just one more 27 bp [basis point] cut this year — down from three in our earlier forecast — and see that as more of a symbolic reaction to deflation."

Jing Ulrich, JPMorgan's chairwoman of China equities, said that the deflationary trend should reverse as the impact of government spending to stimulate demand takes hold.

However, she added: “Deflation is the symptom of a weak real economy and industrial overcapacity, which has left companies with little pricing power.”

Chinese officials were more gloomy. Chen Deming, the Commerce Minister, said that trade figures for February would show declines: “It's fair to say in coming months we will see quite a grim picture.”

Li Yizhong, the Industry Minister, said that power consumption, a key indicator of economic activity, fell by 3.7 per cent in January and February from the same period last year.

“We should not be overly optimistic," he said. "China’s industry is still in its most difficult situation. The international financial crisis has not bottomed out and it is having a more and more profound impact on China's economy.”

And there was bad news from a sector of the economy that has been among the most buoyant.

Urban property prices fell 1.2 per cent in February from a year earlier, the steepest annual decline since official records began in 2005.

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