Chinese inflation: Going hog-wild?
On Friday, we are likely to receive confirmation that Chinese inflation jumped to almost 3% in February, up from 1.5% previously. Higher Chinese inflation conjures up scary scenarios. It could force the People's Bank of China into hiking interest rates when the economy is slowing and saddled with massive debt. It could also add to building inflationary pressures in the US and UK, hastening interest hikes and weighing on equity and bond prices. But relax! The jump in Chinese inflation shouldn’t trigger any of this.
The chart below shows that Chinese inflation has been unusually low over the past year due to a fall in food prices. In February, this 'base effect' will drop out and the headline inflation rate is likely to shoot up as a result. If we forecast food and non-food inflation with their average month-on-month inflation rates, inflation should reach 3% in late 2018.
However, 3% is the authorities’ inflation target and therefore this should not trigger any monetary policy response. Also, this inflation is being driven by food prices (i.e. supply side factors) as opposed to excessive demand.
Admittedly, non-food inflation is unusually high, but this mirrors the rise in producer prices. The latter are now softening and are likely to continue to do so since the bulk of excess capacity reductions are behind us. In addition, growth is expected to slow, further weighing on inflation.
As to the global implications: Chinese inflation dynamics are driven by food prices, particularly pork prices, and as such are largely a domestic phenomenon. This is confirmed by the lack of correlation between Chinese and US inflation, as shown in the chart above.
So the world may well overheat over the next few years, but China is unlikely to be the culprit.