Inflation Pressures on the Way in China

In a recent Equity Research report, Credit-Suisse covered various measures of the Chinese economy to illustrate both the health of, and the risks to, China’s economy this year.

The headline PMI for April edged up 0.6 to 55.7 over March despite the quantitative tightening the authorities have been applying since the beginning of the year. The New Order Index has risen 1.2% to 59.3 with an increase in almost all sub sectors. This suggests the Chinese economy has broadly maintained solid growth with only new export orders remaining flat although at 54.5 still well into positive territory. Imports at 53.1 in April compared to 53.7 in March are still above 51.6 in the second half of last year but appear to be moderating. Although with flat new export orders, this suggests the economy will be back into a positive trade balance soon.

The not so surprising (for readers of MM reports over the last 3 months) but nevertheless disturbing increase is the Input Prices Index, which surged by 7.5 % to 72.6. Credit-Suisse says this is the first time the index has broken through the 70 mark since July 2008. Almost all sub-sectors saw rising prices in April but metal goods and metal smelting led the way.

Should this feed through into increased consumer price pressure interest rates may soon have to rise. The metals markets have reacted strongly to the minor quantitative tightening steps the authorities have enacted so far. Increasing bank reserve requirements and tightening lending criteria have actually been quite gentle controls so far as the government has tried to maintain the direction of property prices but reduce the pace of property price increases. But if inflation breaches 3% in the coming months, the bank expects the People’s Bank of China to raise interest rates and recommend an appreciation of the RMB. The impact on metals prices of such a move could be more significant than the impact of the gentle tightening in reserve requirements we have seen so far.

There is no doubt that China achieved phenomenal growth during the turmoil of 2009, growth that also contributed to an earlier return to health of other countries economies and certainly provided a beacon of confidence for struggling economies elsewhere to draw inspiration and optimism from. But now China could be about to pay the price for that phenomenal growth if they do not move decisively to stem inflationary pressures that for the first time are moving from expectation to reality.

–Stuart Burns

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