Caixin
May 10, 2021 08:14 AM
ECONOMY

Cover Story: Is Global Inflation About to Take Off?

Factories around the world are facing headwinds from surging commodity prices, rising shipping costs and semiconductor shortages, fueling worries that global inflationary pressures are looming as major economies recover from pandemic lockdowns.

Copper, the economic bellwether metal, soared 80% over the past year to a record high, leading a rally that’s driven raw materials ranging from lumber to iron ore to multiyear peaks. On May 6, the New York-based Commodity Research Bureau Index, which measures the aggregate price direction of various commodity sectors, rose to the highest level since September 2011, reading 55% higher than in March 2020. Meanwhile, a global food price index issued by the United Nations’ Food and Agriculture Organization (FAO) climbed for 10 consecutive months and reached a record in March.

Unprecedented stimulus measures and vaccine rollouts in developed economies are fueling prospects for a resurgence in demand that may further push up prices. In the face of rising costs, U.S. consumer goods producers Coca-Cola Co. and Procter & Gamble Co. recently announced plans to raise prices for some of their products in the domestic market, fueling concerns that supply-side pressures are spilling over to the demand side.

The surge in raw materials is stoking fears of inflation. And the key question for policymakers and market analysts is whether the price increases will be short-lived or will morph into long-lasting and broad-based inflation?

In China, factory gate prices have climbed at an accelerated pace in recent months. The producer price index (PPI), which gauges changes in prices of goods circulated among manufacturers and mining companies, rose 4.4% year-on-year, in March, the fastest growth since July 2018. The trend further strengthened in April as prices of coal, steel, cement and glass all increased significantly.

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A worker handles newly formed copper cathode sheets in a warehouse at the KGHM Polska Miedz SA copper smelting plant in Glogow

Analysts have largely agreed that producer prices will continue rising into the second quarter, but disputes remain about whether the price surge will be effectively translated to the consumer side. China’s consumer price index (CPI), the main gauge of consumer goods and services costs, rose 0.4% year-on-year in March, the first monthly rise this year but far from a concern.

“Whether the producer-price rise will spread to the consumer side will mainly depend on the magnitude and duration of the PPI rise,” said Xu Wei, an analyst at the Development Research Center of the State Council.

Reviving demand amid the economic recovery strains supply, which was already under pressure due to disruptions caused by the Covid-19 pandemic, along with extreme weather and economic structural transformation, Xu said.

The global economy’s path out of the Covid-19 shock will be different from that of previous crises because of broad-based pent-up demand and different inflation dynamics, asset management house BlackRock Inc. said in a recent research report. It is more like an economic “restart” than a typical business cycle “recovery,” the report said.

The pandemic’s impact on the global economy is not only the broad production halt but also long-term factors that reduce the resilience of global supply chains, said Peng Wensheng, chief economist at China International Capital Corp. (CICC). In addition to hindering production and transport of raw materials, the pandemic also encouraged companies to expand inventories, widening the gap between supply and demand. The global chip shortage is a good example, Peng said.

Rather than across-the-board inflation, pressures of price rises are unevenly affecting different economic sectors in China, reflecting the country’s structural issues, said Li Xunlei, chief economist of Zhongtai Securities Co.

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While prices of production materials are surging, prices of consumer goods have generally remained stable. Meanwhile, high-end consumer goods costs are rising faster than those of lower-end goods, and price gaps between regions are widening, Li said.

The Politburo, China’s top policymaking body, pledged in late April to ensure the supply of goods that are key to people’s livelihoods and maintain price stability. The body also issued new measures to prevent housing speculation. Analysts said the statements signaled that the central bank won’t tighten monetary policy in response to the commodity price surge. Instead, it will use more-targeted measures such as adding to supplies of certain products to stabilize prices.

The room for monetary policy maneuver is limited for addressing structural inflation. More efforts should be made to advance restructuring, analysts said.

Inflation jitters

Recent concerns over looming inflation risks have mounted mainly among companies and investors rather than general consumers.

In China, prices of food declined after a short spike around the Chinese New Year holidays in February. In March, the official reading for year-on-year CPI growth was 0.4%, the highest since November but 0.5% lower than the previous month, indicating little inflationary pressure on consumer goods.

But producing companies say they see a different picture. In financial reports issued in late April, many companies cited rising material costs as the main factor affecting their first-quarter results.

Data from the National Statistics Bureau showed that rising costs of oil production and refining, petrochemicals, and metal smelting and refining were the main drivers of the PPI rise in March.

Guo Lei, chief economist at GF Securities, said the price rises in heavy industries reflect impacts from global economic recovery, unfolding emission-reduction campaigns and raw material supply shortages due to a worsening of the pandemic in some resources-rich countries.

carbon

China’s surge in raw material prices also reflects pressure on high-polluting industries to cut capacity.

The global campaign to reduce carbon emission to contain climate change is one factor that pumps up commodity prices. Copper, the best electrical conductor behind the precious metal silver, has led the global commodity surge as its crucial role in the green-energy transition is set to underpin longer-term gains.

Goldman Sachs estimated that demand for copper is likely to grow as much as 900% by 2030, led by renewable energy sectors including electric-vehicle manufacturing. Prices of other electrical conductivity materials including aluminum and silver have also climbed.

China’s surge in raw material prices also reflects pressure on high-polluting industries to cut capacity. The central government has set targets this year to slash crude steel capacity and reduce the share of coal in total energy consumption. Major coal and steel production regions have unveiled plans to limit production, triggering price rises due to concerns over declining supplies.

Experts said recent raw material price surges reflect growing market anxiety about the policy impacts and warned policymakers to make long-term arrangements to gradually advance decarbonization efforts.

The green-energy transition will bring rising costs for the economy but doesn’t mean that all the costs should be digested intensively in a short period, CICC’s Peng said. Former central bank Governor Zhou Xiaochuan also warned regulators to manage the pace of carbon reduction to reduce the risks of inflation.

The Politburo vowed April 30 to push forward the carbon neutrality campaign in an “orderly manner,” signaling an easing of pressures on the coal and steel industries to slash capacity, analysts said. The softer tone reflects authorities’ concerns over potential inflation risks caused by supply cuts, according to Ming Ming, an analyst at Citic Securities.

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Analysts mostly agree that China’s producer prices will continue rising during the second quarter, but their projections for the second half vary. Some said the current wave of commodity price increases — mainly caused by global liquidity easing, government stimulus and the mismatch of supply and demand — will not continue into the second half. But others said the rising trend won’t reverse soon.

Nevertheless, officials and analysts have downplayed concerns that Chinese consumers will face broad-based inflationary risks, citing the country’s massive domestic industry and abundant supply of consumer goods.

Policy response

Global central bankers may find that their monetary policy tools are less effective in countering the current round of inflation.

“Short supply is seen worldwide in the short term as the supply side lags behind the demand side in the recovery,” said Zhang Jun, an economist at Morgan Stanley Huaxin Securities. “It is not something monetary policy can solve.”

The pandemic brought disruption to both supply and demand, but the two sides are not on the same pace of recovery, said Pan Hongsheng, a senior analyst at the China Institute of Finance and Capital Markets.

While China’s liquidity returned to normal in summer 2020, the economy has faced uneven inflationary pressures. That means policymakers need to deploy more-targeted, more-flexible measures to strengthen the recovery rather than making a major shift in monetary policy, Pan said.

Consumption recovery is the key to China’s 2021 economic performance, said Sheng Songcheng, a former head of the central bank’s Financial Survey and Statistics Department. The country needs to further boost consumption while maintaining its monetary policy direction, Sheng said.

The Politburo in late April said monetary policy would remain stable and ensure liquidity at a reasonably abundant level in an effort to defuse market anxiety that liquidity might be tightened amid rising commodity prices.

Guosheng Securities in a research report said the central bank is likely to introduce new policy tools to provide direct financing support to help small businesses counter the challenges of rising costs. In addition, the government may release more strategic energy reserves into the economy while encouraging the fluctuation of the Chinese currency to support the supply-side recovery.

CICC’s Peng said policymakers need to take more-coordinated approaches beyond traditional monetary and fiscal measures to tackle the current supply-side pressures. In the short-term, the most crucial thing is to control the virus and increase vaccinations, he said.

Contact reporter Han Wei (weihan@caixin.com) and editor Bob Simison (bobsimison@caixin.com)

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