Rising CPI signals less leeway for monetary easing

By Zhang Ming Source:Global Times Published: 2018/8/26 21:38:40

Illustration: Xia Qing/GT


China's consumer price index (CPI) jumped 2.9 percent year-on-year in February, accelerating to its fastest pace since December 2013. The consumer inflation reading fell below 2 percent between April and June before rising to 2.1 percent in July. The CPI on a monthly basis also returned to positive territory in July after posting negative growth from March to June.

With China's economic growth now facing downward pressure, is it possible that its consumer inflation might go against the stream and expose the economy to rising stagflation pressures? The answer is a big yes.

It is estimated that between the second half and next year, the median CPI will rise 2.2-2.3 percent year-on-year, driven by food, energy prices and import costs, and the CPI may climb to 3 percent in some months during the period. This would compare with a median reading of 1.7-1.8 percent between July 2016 and June 2017.

Analyzing trends in China's CPI data habitually involves reading into food prices, import prices and money supply growth. In the coming months, food prices and import costs are likely to push up consumer inflation while money supply growth would continue to weigh on CPI growth.

Since February 2017, food prices, specifically pork prices, have maintained downward pressure on the CPI. Pork prices were on a negative year-on-year trend streak for 18 months between February 2017 and this July. History shows that there is a major chance of pork prices regaining growth momentum.

In addition, food prices might be pushed up by two significant factors. The unusually hot summer in the Northern Hemisphere seems to have affected the agriculture and livestock sectors. Besides, escalating trade tensions between China and the US might increase import prices of US farm products such as soybeans as a result of higher tariffs, eventually leading to higher food prices in China. It is likely that food prices, especially pork prices, would make a rebound on a yearly basis for the remainder of the year, serving as a major driver of rising inflation.

It's also the case that the import price index and producer price inflation have long been positively correlated with CPI gains, and the import price index tends to see larger fluctuations than producer price inflation, which in turn usually displays greater fluctuations than CPI growth.

China's producer price index (PPI) rose 7.8 percent year-on-year in February 2017 and then slipped to 3.1 percent in March before trending upward in the four months to July. The PPI rise was 4.6 percent in July.

The rising PPI in recent months was obviously fueled by an increase in import prices. The recent rise in import prices was attributed to surging global crude oil prices.

For one thing, there are signs that geopolitical conflicts in the Middle East will keep escalating. If the US conflict with Iran intensifies to the extent that Iran tries to blockade the Strait of Hormuz, a vital oil chokepoint, the median oil price might continue going up. For another thing, the yuan has fallen by more than 7 percent versus the US dollar since April. The yuan's weakness will add to the cost of imported products.

Other than that, the Chinese government's macroeconomic policy changes, particularly plans to increase infrastructure investment in the central and western parts of the country, will also put upward pressure on the PPI and ultimately be partially passed on to CPI readings. 

Furthermore, there has historically been a positive correlation between the country's narrow M1 money supply and CPI growth, and changes in M1 growth have usually been present six to 12 months earlier than the changes in the CPI readings. Between February 2017 and June, China's M1 growth year-on-year fell to 6.6 percent from 21.4 percent. More importantly, M1 growth remained below growth in broad M2 money supply for a consecutive fifth month in June. This is believed to signal continued declines in economic growth. Falling M1 growth will suppress consumer inflation.

In conclusion, the median rate of CPI growth will trend upward, lifted by rising food, energy and import prices. This will cause stagflationary pressure on the economy, which is already slowing down. If consumer inflation picks up speed, it would indicate less leeway for the central bank to ease monetary policy.

The author is chief economist of Ping An Securities and a research fellow at the Institute of World Economics and Politics of the Chinese Academy of Social Sciences. bizopinion@globaltimes.com.cn


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