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China: Producer cost burden and inflation risks rise

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In China, the producer price index increased by 13.5% compared to the previous year, reaching the highest pace in 26 years, exceeding the median estimate of 12.3%. The consumer price index rose 1.5%, the fastest since September 2020, above the predicted 1.4% increase. The gap between producer costs and the increase in consumer prices widens, and as the producers bear more on the costs, the risks of inflation on the consumer basis also increase. Demand conditions in the market, centralized price controls and the not fully liberalized economy keep this reflection coefficient low. Therefore, we do not yet see the transition effect as in the US. Besides, we observe that there is a compelling inflation level for the PBOC, which tends to decrease RR at the point of increasing the loan rate.

 

The rise in global commodity prices and production cuts on the energy side form the basis of the increase in producer prices. In addition, weather conditions and agricultural production-effective food prices have a greater impact on retail prices. We read the future reflection of general cost underwriting on consumer prices as higher inflation, albeit with slower effects. There is a weakening normal of economic growth. In addition to inflationary factors, electricity and production cuts, a decline in the real estate sector and virus outbreaks pose a weaker economy risk. Although policy makers have reduced RR at certain rates to support growth, it does not seem theoretically possible that increasing inflation will allow further policy easing. Centralized price controls can be used to lower the PPI side, but this will cause producers’ profit margins to be unsustainable. We also do not consider it possible for the PBOC to tighten monetary policy due to growth concerns.

 

Therefore, at this stage, stabilization of raw material and commodity prices seems to be a necessary condition for normalizing inflation. We can expect the central bank to consider inflation as a side indicator due to the suppressed CPI, and to make limited RR cuts in order to keep the growth conditions at the desired level.

 

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