The markets paused for thought when the Bank of China raised the requirement for big commercial banks to keep 16% of deposits at the central bank, up from 15.5% before. The impact was not so marked in China where the Shanghai Composite Index is off less than 1% this year but more in overseas markets which had been fooling themselves that China’s loose monetary stance would go on forever. As it is the monetary policy of last year is likely to drive consumer price inflation to 3% or more this year, the turnaround starting in October when it was at -0.5% to December which was at +0.6% according to the FT. Consumer demand, housing, foreign direct investment and bank lending are all still powering ahead. Raw material prices have doubled admittedly from low levels due to the financial crisis but they are still now back at what appear to be historically high levels. M1 money supply the narrow definition of money in circulation has gone stratospheric as this graph from the FT illustrates:
On a month-on-month annualized basis, the national property price index rose by 14% in December. Residential and commercial real estate prices rose at the fastest rate in 18 months in December, while foreign direct investment more than doubled from a year earlier according to another FT article. And still the banks are lending. The Rmb600bn of new loans in the first week of January was not far off the monthly average of Rmb800bn last year. The Bank of China has repeatedly rebuked any suggestion to raise the Renminbi exchange rate which would have the benefit of at least reducing raw material costs and easing some supply side inflationary pressure.
So the question appears to be not will inflation raise it’s head in China but how far and how fast. The OECD markets will also face the same problem but further down the road. Recovery has to pick up steam considerably before it will become an issue in Europe and the US but with so much capacity cut back in the west last year utilization levels are actually higher than one would expect for many materials. Steel for example is back to 70%+ and mill lead times are beginning to move out. That will result in gradually higher prices even if the long awaited re-stocking does not materialize in the short term.