China's trade balance may have just hit a record on the back of resurgent exports and slowing inflation, but the favorable impact to China's mercantlist economy was more than wiped out by the just released record PPI and resurgent CPI.
China's National Bureau of Statistics reported that in October, CPI rose 1.5% Y/Y, higher than the 1.4% expected, and a 0.7% sequential increase from the September print; the CPI increase was evenly split between base effect and sequential growth.
At the same time factory gate, or PPI, inflation hit a fresh all time high of 13.5%, steamrolling the 12.4% consensus estimate, and rising at the fastest pace since records began in November 1995.
While the gradual increase in CPI is alarming, and the NBS said that it was affected by weather, commodities demand and costs - it was the producer price inflation that was far more alarming, soaring as a result of a tight supply of energy and resources. In reality, however, there was just one key variable - thermal coal, which as we said last month indicates that PPI will continue rising far higher, although judging by the recent sharp reversal in the price of Chinese thermal coal (if only for the time being), this may be as high as PPI gets.
Or so Beijing should hope because with the spread between PPI and CPI hitting a new all time record, virtually no Chinese companies that use commodity inputs - which in China is a vast majority - are making any profits.
The gap between upstream and downstream prices “continues to highlight weak consumer demand in the economy and the immense pressure on profit margins downstream firms are facing,” said Michelle Lam, greater China economist at Societe Generale SA in Hong Kong.
The latest price jump comes against the backdrop of a weakening economy as electricity shortages, a slump in the property sector and virus outbreaks weigh on activity. Rising inflation will likely reignite the debate over whether the central bank can provide more policy easing to help support growth.
Some more details on the latest data:
- In year-over-year terms, food inflation rose to -2.4% yoy in October from -5.2% yoy in September, due to both a low base and a sequential increase in prices month-on-month. The increase of food inflation in October was broad-based (particularly an extreme increase in vegetable prices). Pork prices, a big driver of CPI, continued to decline in October, and that helped to mask a rise in other food costs. Deflation in pork prices eased slightly to -44.0% yoy in October from -46.9% yoy in September, primarily on a favorable base effect. Overall CPI would have risen almost 2.5% if not for the effects of falling pork prices, according to the NBS.
- Inflation in fresh vegetables rose to 15.9% yoy in October from -2.5% yoy in September, contributing 0.33 percentage point to the increase in CPI while the price of fresh fruits increased to 0.5% yoy in October (vs. -0.8% in September), both primarily on the back of sequential increases in prices. Prices of freshwater fish, eggs and edible vegetable oil also rose sharply in October from a year ago. Vegetable prices have jumped since mid-October following supply disruptions, prompting the government to crack down on hoarders.
- Non-food CPI inflation increased to +2.4% yoy in October from +2.0% yoy in September, primarily on a sequential increase (especially fuel costs). Fuel costs increased by +31.4% yoy in October (vs. +22.8% yoy in September).
- Core CPI inflation (headline CPI excluding food and energy) edged up to +1.3% yoy in October (vs. +1.2% in September), with inflation in services flat at +1.4% yoy in October. In other words, producers are passing on a growing part of their own surging costs on to consumers, but nowhere near all as the record gap between CPI and PPI shows.
- And speaking of PPI, producer price inflation rose to +13.5% yoy in October from +10.7% yoy in September, largely on strong sequential growth. PPI inflation in producer goods rose to +17.9% yoy in October from +14.2% yoy in September, and PPI inflation in consumer goods edged up to +0.6% yoy in October (vs. +0.4% yoy in September). Among major sectors, in seasonally adjusted non-annualized month-over-month terms, inflation in coal mining increased the most (+17.2% in October from +10.5% in September), followed by upstream sectors, such as petroleum/coking and chemicals. In year-over-year terms, coal mining picked up the most due to both high sequential growth and a low base.
Looking ahead, Goldman predicts that headline CPI inflation is likely to continue rising in the coming months as high frequency data suggest that the year-on-year decline in pork prices tightened in early November, and year-on-year inflation in fresh vegetables and fruits picked up. Needless to say, PPI inflation is expected to stay elevated in the near term, although as noted above, October may be the peak given the recent decline in coal prices.
Xing Zhaopeng, China strategist at Australia & New Zealand Banking Group agrees and writes that while the impact of vegetable prices might be short-lived, rising demand before the upcoming Chinese New Year might drive CPI higher in the next couple of months.
Or maybe not, because while Beijing has succeeded in dragging coal prices lower now, it is only at the expense of a far bigger surge in coal in the future. And while China may be facing its first "galloping inflation" PPI print since the early 90s, it's only downhill from there, because as Citigroup wrote recently, power cuts (with over 20 provinces, making up >2/3 of China’s GDP, have rolled out electricity-rationing measures since August) and contractionary PMI "seem to suggest China could enter into at least a short period of stagflation."
Local stocks were certainly not happy, with China’s CSI 300 Index sliding as much as 1.3% amid signs that producers are passing on higher costs to consumers, and that the PBOC may have no choice but to tighten financial conditions at the expense of risk assets. Several food companies have already announced price hikes of up to 15%, including Haixin Foods, Anjoy Foods and Jiajia Food, due to rising costs for raw materials.
The stronger than expected inflation data is “bad news for the A-share market,” according to Ken Chen, an analyst at KGI Securities Co., referring to the stocks of companies listed on mainland exchanges. “The market is expecting some policy support to help the weak economy, but the CPI data may give limited room” for any stimulus, he said echoing what Zhang Zhiwei, chief economist at Pinpoint Asset Management, said last month: “We think the risk of stagflation is rising in China as well as the rest of the world. Persistent inflationary pressure limits the potential scope of monetary policy easing.”
Liu Peiqian, China economist at Natwest Markets expects policy makers to keep prioritizing stabilizing supplies and prices of commodities and raw materials to tame PPI inflation, while the People’s Bank of China is unlikely to tighten monetary policy, as CPI remains well below target.
Commenting on the latest inflation data, Bloomberg's China economist David Qu said that "the acceleration in China’s inflation in October is probably a bit of a side show for the central bank -- we don’t expect the People’s Bank of China to take its eye off the need to cushion a slowdown in the economy. We still expect it cut banks’ required reserve ratio by another 50 basis points in the next month or so."
And so, Beijing is now trapped: if it eases, inflation - already at nosebleed levels - will soar further crushing margins and sparking a deep stagflationary recession; if it does not ease, the property market - already imploding - will crater.