Oh yay, Chinese consumer price inflation for July came in at a nicely subdued looking 1.8 per cent. And industrial production growth continued to slow. Q2 wasn’t the bottom after all. More easing ahoy! Right?
Not so fast…
Alistair Thornton of IHS Insight says consumer inflation isn’t necessarily conquered — soybean prices are rising due to the US droughts, and in future months the year-on-year figure will be elevated by the base effects of last year’s deceleration.
But inflation is not the big concern right now, says Thornton; it’s the continuing deflation showing up in the producer price index (emphasis his):
At present, inflation remains tame. Nowhere more so than in producer prices, which continue to highlight the severe deflationary pressure rippling across the country. Not one of the 16 PPI sub-indexes registered a positive month-on-month number. Deflation, not inflation, is the greatest short-term threat to the Chinese economy.
As such, authorities are no doubt aware that this is the time to act. This doesn’t necessarily mean another rate cut and reserve ratio requirement reductions, although the latter will almost certainly come. It means that local governments in collaboration with the NDRC, enabled by the all-clear for local platform financing and debt roll-overs, will be presiding over a surge in projects and government investment. In this respect, it matters less how far inflation falls, and more how much investment rises.
Back to the continuing risk of consumer price inflation, which Wei Yao of Societe Generale agrees could continue to be a problem, particularly with the politically-sensitive food prices. Wei has this forecast:
Looking ahead, we think upward inflation pressures – especially from food prices – are going to dominate the CPI trend till the year-end, pushing the headline back above 3% in late Q4. However, PPI is likely to remain deeply negative in yoy terms until early 2013.
This combination of consumer price inflationary pressure with producer price deflation creates a monetary policy dilemma, she says. Which is just what the PBoC doesn’t need right now.
Should the PBoC focus more on maintaining a positive real deposit rate for households or on alleviating the pain felt by sectors with excess capacity? We think the PBoC will try to strike a difficult balance by keeping benchmark interest rates unchanged and, at the same time, easing liquidity conditions to lower costs of capital indirectly.
In otherwords, that easing might not take the form that everyone expects. Not that that in itself is a bad thing; the significance of some PBoC measures — especially reserve ratios — is often misinterpreted. The PBoC probably has a decent amount of liquidity firepower before it has to turn to more bluntly inflationary methods (we explain these measures more here and here).
The bigger story is what this all means for China’s economy, and its growth. Industrial production data showed the July year-on-year rise was 9.2 per cent, which was a decrease from the June year-on-year (9.5 per cent) figure and below consensus expectations (9.7 per cent). The graph below from Michael McDonough of Bloomberg Brief shows the monthly year-on-year rate of change, along with the quarterly GDP figures:
This underlines just how difficult (or indeed, unlikely) it will be for China’s policymakers — both fiscal and monetary — to steer the economy towards a more balanced, higher-consumption mix any time soon.
This is the real dilemma: in order to boost growth, it looks like any vestiges of rebalancing that took place in recent months will well and truly be wiped out in the next few months. And that’s the good scenario, remember, as it assumes policymakers have that level of control — they are already walking a tightrope on house prices, for example.
The next question will be, how sustainable will an inevitably capital-intensive rebound be?
China’s two-way liquidity risk: shadow banking – FT Alphaville
Chinese banks’ Weapons of Mass Ponzi – FT Alphaville
China doubles down on imbalance – FT Alphaville
The PBoC’s ‘unofficial’ rate policy – FT Alphaville