Signs of inflation appear as Chinese producer prices jump

For investors and governments keen to spot any signs of inflation as the global economy recovers from the coronavirus pandemic, Chinese factories are a good place to look.

The country this week released figures showing that the price of raw materials and goods leaving its factories rose 6.8% year-on-year, its fastest growth rate in more than three years.

For most of 2020, China’s producer price index was in negative territory as Covid suppressed demand. The recent and sudden increase is partly due to the comparison with a year earlier and, with consumer price increases still below 1 percent, the overall picture for inflation is mixed.

But the data is nonetheless a sign of pockets of price increases emerging across China’s rapid recovery, where higher headline inflation is expected this year. This reflects a global rally in commodity prices that has been supported by voracious demand from China as well as hopes that other major economies will rebound as well.

“A combination of China and external factors has led to this surge in PPI,” said Robin Xing, chief China economist at Morgan Stanley. “It’s like a perfect storm.”

China’s PPI index is made up of the prices of production products, such as cabinets or washing machines, that factories sell to stores before they are sold to consumers.

It also includes the prices of raw materials and commodities, like coal, when sold by companies that extract them to companies that use them to make goods.

It is the latter which is at the origin of the recent surge in Chinese producer prices. Global commodity prices collapsed last year in the early stages of the pandemic and have since rebounded. This week, iron-ore reached its highest level on record, while oil prices recovered sharply from last year.

Xing estimates that 70 percent of the April PPI increase is attributable to commodities. This rally is linked to the recovery in China, which was driven by strong industrial growth and a construction boom that led to record steel production last year.

As such, the data reflects both the pace of the recovery in China, as well as a global commodity rally that has helped fuel and now goes beyond.

For decision makers, a crucial question is whether the rise in producer prices will have repercussions on consumer prices. China’s consumer price index was just 0.9% in April – its highest level in seven months, but far from a level that would raise immediate fears of broader inflation in China .

While economists expect China’s CPI inflation to rise this year, they suggest any reaction to this week’s data from the People’s Bank of China is unlikely. The share of the producer price index that represents the prices at which firms buy consumer goods, as opposed to raw materials, has increased only 0.3 percent year over year.

HSBC analysts noted that the transmission from PPI to CPI would be “limited”, which would allow policymakers to remain “accommodating.”

Ting Lu, chief China economist at Nomura, expects CPI inflation to hit 2.8% by the end of the year, with “pass-through” effects. IPP. But he suggested that the PBoC was unlikely to tighten in response to the IPP and that the rise in commodity prices instead posed a risk to Chinese demand and the broader recovery given the controls on availability. credit.

“For a typical borrower, $ 1 billion six months ago might be enough to buy steel and cement to complete a project, but today is [maybe] no, ”he said.

While the PBoC has not raised official rates since lowering them last year, the Chinese government has nonetheless tightened credit conditions in recent months.

It has also taken steps to contain both its real estate sector, fearing that easier money will encourage asset bubbles, and its steel sector, which has produced the metal at a rate that threatens new environmental commitments. .

China’s gradual decarbonization ambitions and the resulting production cuts in the country are seen as supply constraints, pushing the price of raw materials even higher.

Beyond commodities, economists are watching closely for other shortages. Iris Pang, chief economist for greater China at ING, said producer price inflation would be followed by chip inflation. A shortage of semiconductor chips, she said, was already starting to drive price increases for consumer products like washing machines and laptops.

While the PPI index shows a much smaller increase in consumer goods than in commodities, on a monthly basis there are noticeable increases. Durable consumer goods were up 0.4% month-over-month in April, the fastest pace of growth since at least 2011, according to CEIC, a data company.

Besides domestic construction in China, part of the demand for raw materials has been to stimulate the production of goods exported to Western countries.

Data on Friday showed Chinese exports jumped 32.3% year-on-year in April. But even compared to April 2019, before the pandemic, the increase was around 16% on an annualized basis, Morgan Stanley estimated.

Competition among producers in China means that this does not necessarily imply inflation for consumers abroad. Instead, China’s recent PPI jump hints at just one of the global effects of western responses to the pandemic.

“If you’re trying to figure out what the final demand is here for this PPI pickup, it’s a global stimulus,” Xing said. “External demand has led to the resumption of Chinese exports, [and] now it is well beyond its potential growth ”.

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