To expand on Milton Friedman, inflation is everywhere and always a monetary phenomenon, and sometimes in China it is also a porcine one.
The government’s main measure of consumer price inflation hit a near eight-year high of 3.8 per cent in October, smashing through the official 3 per cent annual target, as African swine fever continued to wreak havoc on China’s hog population and supplies of the country’s favourite meat.
The bond market has been understandably nervous as the consumer price index (CPI) has spiked. Investors fear resurgent inflation could stop the central bank from easing monetary policy to support flagging growth.
Yields have dipped after October credit data again highlighted the economy’s weakness. However, panic about inflation will return — the latest read of the CPI, which beat the expected 3.3 per cent, lends credence to forecasts that it could hit 6 per cent in the lunar new year holiday in January.
But the inflationary outcome is likely to be less painful than expected because demand is too weak to support a sustained rise in the CPI, while the People’s Bank of China needs to stay vigilant and keep a lid on interest rates to contain default risks in China’s credit-saturated financial system.
Its vigilance was on display last week with a 5-basis-point cut to the rate on the PBoC’s medium-term lending facility (MLF), the anchor of the central bank’s new interest rate regime. The move, the first since 2016, was probably a response to the inflation-spooked rise in bond yields, which threatened to raise the cost of financing in this brittle economic climate.
This latest bout of pork-fuelled inflation stands in contrast to 2006 and 2007, when an outbreak of a respiratory illness in China’s pig population called blue ear disease saw pork prices rising more than 80 per cent. At the time, the PBoC was already battling inflationary pressure from a torrent of capital inflows and M2 money supply growing at nearly 20 per cent. The bank responded by raising its then-key policy rate by a cumulative 189 basis points over 16 months from mid-2006.
This time is different. Apart from the devastation of the pork industry, inflationary pressure is weak because of demand softness in the economy. The headline CPI may be at its highest level in six years, but the non-food CPI rose just 0.9 per cent in October — it has not been this low in four years — while producer prices were down for a fourth consecutive month on the back of demand weakness in Chinese industry. For all the speculation surrounding the timing and size of economic stimulus, growth in the outstanding stock of total social finance, a measure of credit growth, dropped to a five-month low of 10.7 per cent in October.
Non-food inflation is subdued partly because disposable household income is not rising fast enough relative to GDP growth. Households are getting a smaller share of GDP, so consumption is weak. Furthermore, the M2 money supply is growing barely more than 8 per cent as a result of the government’s efforts to contain risk in the financial system, denying inflation its necessary fuel.
If anything, rising food prices will damp consumer spending on other goods — prices of other meats are rising sharply as well — giving inflation more of a downdraught.
The PBoC says it is monitoring inflation expectations. A monthly survey by FT Confidential Research of 1,000 consumers shows these are subdued. In October, consumers estimated their cost of living would rise 7.6 per cent on average over the next six months, only slightly higher than the 7.3 per cent average of the past year. On average, consumers estimated their cost of living had risen 7 per cent over the past year, suggesting a higher rate of inflation than shown by government estimates but below the average 7.5 per cent of the past 12 months.
This all suggests price rises are not being passed along to the retail level by wholesalers, and the government is likely to cushion the blow when they are, providing direct subsidies and increasing imports. China’s leaders are acutely sensitive to the threat posed by inflation because of its role in fuelling political upheaval. Last week’s meeting of the State Council, the senior executive decision-making body, was devoted to discussing price stability.
The PBoC will need to keep a lid on rates because China’s economy is sitting on a mountain of debt, meaning credit risks need to be kept in check and growth kept humming. The PBoC may struggle to push through more interest rate cuts as CPI surges through November and December, but last week’s move to trim the MLF rate shows the inflation scare is not a binding constraint on policy.
Bond yields could resume their upwards march as CPI readings worsen, but investors should focus instead on the small print, which suggests that China is not experiencing another inflationary blowout.
— He Wei, Finance Researcher, FT Confidential Research
FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.