Wang Tao: China’s Growing Inflation Won’t Be Not Enough to Alarm the Central Bank
CPI inflation picked up thanks to rising nonfood prices
Headline consumer price index (CPI) inflation narrowed its sequential decline to a 0.3% month-on-month drop from a 0.5% month-on-month fall previously, with food prices dropping less by 2.4% month-on-month while nonfood prices rose 0.2% month-on-month again. Together with last year’s low base, headline CPI picked up to 0.9% year-on-year from 0.4% year-on-year previously, mainly due to an uptick of nonfood inflation by 0.6 percentage points to 1.3% year-on-year.
In particular, the price of pork fell by another 11% month-on-month (21% year-on-year), while touring and outgoing prices jumped by 4.7% month-on-month (2.4% year-on-year) in light of strong holiday demand and continued control over then pandemic. Although the price of fuel slipped by 0.7% month-on-month, its year-on-year reading continued to rebound by 8 percentage points to 19.4% due to a low base. Excluding food and energy prices, China’s core CPI inflation edged up to 0.7% year-on-year, much higher than the first quarter’s average of 0%.
PPI inflation jumped on surging upstream prices and low base
April producer price index (PPI) inflation continued to increase sequentially by 0.9% month-on-month, a bit slower than its record high 1.6% month-on-month pace in March, mainly driven by cooler price growth in oil and nonferrous metals. That said, ferrous metals prices jumped by 5.6% month-on-month, 0.9 percentage points more than previously, echoing recent sharp surge of steel prices in China.
Meanwhile, manufacturing goods prices grew by 1.3% month-on-month again (up 5.4% year-on-year versus 3.4% year-on-year previously), while consumer goods prices stayed soft at 0.1% month-on-month. Due to a much lower base last year, headline PPI inflation jumped by 2.4 percentage points to 6.8% year-on-year, with prices of mining (up 25% year-on-year) and raw materials (up 15% year-on-year) leading the strength. In contrast, price growth of consumer goods remained largely tame at 0.3% year-on-year.
CPI to rise gradually while PPI to peak around May-June
Global demand recovery, overseas supply disruptions due to pandemic, and tight controls on domestic production (for example, operating rates of Tangshan’s steel blast furnaces were only 47% in April) have pushed up upstream prices both globally and at home, fueling the sharp increase of PPI in the past months.
We expect the sequential momentum of PPI to fade and some commodity prices to drop later in the year, as commodity-intensive activities slow and supply grows. With the fading base effect ahead, we expect PPI’s year-on-year growth to peak around May-June at more than 7% year-on-year, while staying elevated in the second half of this year. To put it into context, the previous highs were 7.8% in February 2017, 7.5% in July 2011, and 10.1% in August 2008. While some of the PPI strength may transmit to downstream sectors into core consumer goods prices, the magnitude will likely be limited given the competitive landscape, which may weigh on the profit margins of some downstream companies. With continued weakness in food prices, we expect average headline CPI to rise to around 2% in the third quarter and more than 3% in the fourth quarter, leading to an average CPI at around 1.7% in 2021.
Inflation pressure in focus, central bank unlikely to tighten aggressively
The surge of PPI inflation, especially in upstream prices, has increased input cost pressure, notably for mid- and downstream sectors. It may squeeze profit margin for the latter, and impose upward inflation pressure for final consumer goods. Some local governments are still tightly controlling production over upstream products for the sake of environmental protection and “carbon neutrality.”
That said, we think the government may temporarily increase flexibility of production controls to further rein in the sharp increase in commodity and raw material prices. As the pass-through of PPI to CPI is still modest, the People’s Bank of China (PBOC) may be in a “wait-and-see” mode in monitoring inflation pressure. We continue to expect credit growth to slow further to around 11% by end-2021 and market interest rates to edge up in May-June before cooling in the second half. We still expect a 5 basis point hike in medium-term lending facility and repo rates in September-October. That said, we don’t think the PBOC will tighten liquidity or hike rates aggressively, as the CPI may stay largely controllable through most of 2021 and some supply side disruptions are likely transitory.
Wang Tao is the head of Asia economics and chief China economist at UBS Investment Bank. Zhang Ning is a senior China economist at UBS.
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Wang Tao is the head of Asia economics and chief China economist of UBS Investment Bank.
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