Critical Takeaways From Cooling Chinese Inflation

Consumer prices and factory gate inflation rolled over in China last month, key data out Wednesday showed, bolstering the case for policy easing from the PBoC, a boon to risk assets.

PPI rose 10.3% YoY in December (figure below), a full percentage point cooler than consensus and below the lowest estimate from nearly three-dozen economists. The range was 10.5% to 12%.

China has, of course, moved to tamp down the surge in factory inflation with the kind of zeal typical of official efforts to address problems seen as inconsistent with policy goals.

CPI, meanwhile, rose 1.5% YoY, a few ticks short of the 1.7% the market expected and well off November’s 2.3% pace. Core prices rose 1.2% last month, unchanged from November. Food prices dropped 1.2%. An ongoing collapse in pork helped keep a lid on things.

The world’s second-largest economy is beset with difficulties. Although the worst of the property slump may be in the rearview, the country’s worst (and most persistent) COVID outbreak since the onset of the pandemic is testing the Party’s “zero COVID” strategy and threatens to further hamper already strained supply chains. The last time China reported no local cases was October 14.

A loosening of restrictions is seen as unlikely ahead of the Winter Olympics. As Bloomberg wrote, summarizing on Wednesday, Delta and Omicron outbreaks “have already triggered shutdowns to clothing factories and gas deliveries around one of China’s biggest seaports in Ningbo, disruptions at computer chip manufacturers in the locked-down city of Xi’an, and a second city-wide lockdown in a different province Tuesday.”

By November, it was clear that officials had reached the pain threshold as the combination of the property slowdown, an acute energy crunch, COVID and the hit to sentiment from rolling regulatory crackdowns undermined growth expectations. An RRR cut on December 6 and news that the PBoC also lowered the relending rate for SMEs suggested China had already embarked on an easing cycle, even if officials avoided branding it as such.

The one-year loan prime rate, the de facto policy rate which underwent a reformulation in the summer of 2019, fell for the first time in 20 months in December (albeit by a token five basis points), while a statement released following the PBoC’s regular Q4 meeting clearly telegraphed the central bank’s intent to actively support the economy.

Falling inflation arguably cements the case for additional easing, with some analysts projecting OMO cuts as soon as this week.

Recall that the small reduction in the one-year LPR last month came despite no change to the MLF rate, off which LPR is priced. If you do see a cut to the seven-day repo rate (blue line in the figure, above) this month, expect it to be followed by commensurate cuts to the 14-day rate and then MLF, opening the door to another, perhaps larger, LPR reduction. Analysts generally expect more RRR cuts this year as well.

Expectations for imminent easing bolstered Chinese equities. The ChiNext logged its first gain of 2022, jumping 2.6% in the best session since late November (figure on the left, below).

Meanwhile, the Hang Seng Tech Index surged 5% (figure on the right, above), helped along by overnight gains in US tech shares. The gauge is the poster child for Xi’s “common prosperity” crackdown. The index’s ~50% drop from the highs hit in February 2021 exemplified the Party’s efforts to rein in big-tech and otherwise course correct in a bid to rebalance the economy and society more generally.

Credit data for China, also out Wednesday, showed new yuan loans were 1.13 trillion in December, short of estimates, while total financing was 2.37 trillion yuan, roughly in line with expectations. Outstanding credit growth was 10.3%, brisker than November’s 10.1% pace, while M2 growth, at 9%, was up handily from the previous month and matched the highest estimate from 31 economists.

Perhaps the most important takeaway was summarized by former Lehman trader Mark Cudmore. “There’s an intuitive relationship between China PPI and US CPI,” he wrote. “At the simplest level, the former measures the input prices for the world’s largest manufacturing base while the latter covers the output prices for the biggest consumer base on the planet.”