In the U.S., consumers are paying more for everything. In China, the inflation problem is very different
Persistent inflation in China narrows the window for when the People’s Bank of China can cut interest rates and support growth, economists said.
Official measures of producer and consumer prices in China rose in March by more than analysts expected, according to data released Monday.
“Rising food and energy price inflation limits the space for the PBoC to cut interest rates, despite the rapidly worsening economy,” Nomura’s chief China economist Ting Lu and a team said in a note Monday.
Lu referred to his team’s report earlier this month that noted how China’s 1-year benchmark deposit rate is only slightly above the rate of consumer price increases. That reduces the relative value of Chinese bank deposits.
On an international level, higher U.S. interest rates narrows the gap between the benchmark U.S. 10-year Treasury yield and its Chinese counterpart, reducing the relative attractiveness of Chinese bonds. Cutting rates in China would reduce that gap further.
The yield on China’s 10-year government bond fell below that of the U.S. for the first time in 12 years on Monday, according to Reuters. Previously the Chinese bond yield tended to trade at a 100 to 200 basis point premium to the U.S.
“We think April could be the last chance for China to have a rate cut in the near term before [the] Fed’s potential balance sheet shrink,” said Bruce Pang, head of macro and strategy research at China Renaissance.
Fed meeting minutes released last week showed how policymakers generally agreed to reduce the central bank’s holdings of bonds, likely starting in May, at about double the rate prior to the pandemic. U.S. consumer price data is due out overnight.
“Rising inflation, if [it] continues, could further limit China’s room for policy maneuvers,” Pang said.
He noted how Chinese investors increasingly expect the PBOC to act after high-level government comments this month.
China will adjust monetary policy “when appropriate” to support growth, Premier Li Keqiang said at a meeting last week of the State Council, the top executive body.
Profit margin squeeze
The producer price index rose by 8.3% in March, slower than the 8.8% increase in February and the lowest since April 2021, according to Wind data. Coal and petroleum products contributed some of the largest gains.
Within the consumer price index, the largest increase was in transportation fuel, up by 24.1% year-on-year in March. The global price of oil has surged since the Russia-Ukraine war began in late February.
China’s consumer price index rose by 1.5% in March, up from 0.9% in February and the fastest since consumer prices rose by the same pace in December, Wind data showed. A sharp, 41.4% year-on-year decline in pork prices continued to drag down food inflation. Vegetable prices rose by 17.2%.
“China’s inflation dynamics implied a continued margin pressure on Chinese corporates,” said Bruce Liu, Beijing-based CEO of Esoterica Capital, an asset manager.
“March inflation was not the only force that brought down Chinese equity markets [on Monday], and the rising-real-yield-induced equity sell-off last Friday in the U.S. spilled over,” Liu said. “More Covid worries in multiple places outside Shanghai (Guangzhou, Beijing, etc.) also weighed on market sentiment, and investors got their hands full at the moment.”
The U.S. 10-year Treasury yield climbed to a three-year high Friday and rose further overnight on Monday to 2.793%, its highest since January 2019. China’s 10-year government bond yield held around 2.8075% Tuesday, according to Wind Information.
Citi analysts expect the PBOC could, as soon as this month, cut at least a policy rate or the reserve requirement ratio — a measure of how much cash banks need to have on hand. They said the prolonged omicron wave requires more monetary easing.
“Inflation won’t constrain monetary policy for now, in our view,” the analysts said, “but could become more a source of concern in H2.”
They expect the producer price index to moderate due to last year’s high base — for a 5.6% annual increase — while the consumer price index will likely rise slightly — rising 2.3% for the year— as food prices remain elevated.