China: PPI inflation unlikely to pass through to CPI - ANZ

David Qu, Markets Economist at ANZ, notes that weak food prices dragged China’s CPI lower in February, due to a high base during the same period last year and the Lunar New Year effect as non-food prices rose by 2.2%, food prices dropped by 4.3% y/y, dragging the overall CPI lower by around 1.27 ppt.

Key Quotes

“In particular, vegetable prices declined 26% after the Lunar New Year in January this year, dragging the CPI lower by 0.94 ppt. The Lunar New Year took place in February last year, creating a high base effect on a y/y basis. The high base effects of food prices last year could continue to weigh on the overall CPI in the coming months.”

“China’s PPI remains strong on a y/y basis and may have peaked before softening later in 2017. The strong rise in commodity prices since last year continues to contribute to the PPI. The sub-PPI of the steel, coal and energy (oil and natural gas) sectors rose on-year by 40.1%, 39.6%, and 85.3%, respectively. However, we forecast the PPI to soften later this year, based on our assumption of relatively stable commodity prices through 2017.”

“The transfer from producers’ prices to consumers’ prices is limited. The market has been concerned over the influence of the strong PPI on the CPI. But the data backs our opinion that the transfer effect should be rather weak, due to the structure of China’s CPI basket, wherein food and services form the bulk. As PPI inflation may have peaked, its influence on CPI should also weaken, thus the chance of a strong CPI driven by PPI should be low. The PPI of consumer goods merely increased 0.1% m/m in February, even slower than 0.2% in January.”

“The divergence between CPI and PPI means weakened profitability in the mid- and down-stream industries. Although the gross profit of industrial corporates rose by 8.5% in 2016, it should mainly reflect the improvement in upstream producers and SOEs, which dominate up-stream industries. However, the mid- and down-stream sectors may be further squeezed by higher material costs and relatively stable output prices. This can be seen in the material purchase prices (which rose by 9.9% y/y in February), compared with the PPI (7.8%). One example is the automobile sector, whose output price dropped by 0.6% y/y while the material (steel) price jumped by over 40% y/y.”

“While we expect the People’s Bank of China (PBoC) to continue shifting to a tightening bias, inflation should not be a near-term driver. Given the PBoC’s current priority of preventing an accumulation of financial risks, we still see the chance of a higher 7-day reverse repo rate. However, the lower-than-expected CPI should alleviate the upward pressure on the benchmark deposit or lending rates, and the CNY rates market should react positively to it as a knee-jerk reaction. That said, the market should remain volatile in the near term, as the deleveraging in the shadow banking sector continues, with stricter regulations.”