The increase in China’s January annual consumer price index (CPI) to 4.5 per cent, from January’s 4.1 per cent, ending a five month period of decline, has been generally ascribed to inflationary effects caused by China’s Spring Festival (Chinese New Year). The Financial Times, for example, tagged its coverage ‘Spike blamed on food prices ahead of New Year celebrations‘. The FT’s report noted: 'Chinese inflation jumped in January, breaking a streak of five straight monthly declines, but seasonal factors were largely to blame and price pressures were expected to weaken in the coming months.’
It is certainly true that China’s Spring Festival has powerful, and well known, distorting effects on statistical comparisons, and therefore undoubtedly not too much should be read into one month’s figures. Nevertheless there are reasons to consider that the inflation increase was not purely a holiday effect but reflects international factors.
As this blog has noted previously China’s CPI is not, contrary to claims to the contrary, closely linked to China’s money supply data but it is extremely closely tied to international commodity prices. In this regard it is important to note that since December the annual change in international commodity prices has stopped falling. This may be seen clearly in the end of the decline in the year on year data for the Dow Jones-UBS Commodity Spot Price Index – see Figure 1.
Furthermore year on year data somewhat flatter as they are affected by the base effects of the rapid rise in prices during the early part of 2011. If absolute price levels are analysed then commodity prices reached their recent minimum on 4 October 2011, since which they have risen by 8.2 per cent – Figure 2.
International commodity prices, as always, show strong fluctuations and it would be too early to definitively state that a new round of commodity price inflation is taking place. But certainly the sharp fall in commodity prices, which took place from spring to autumn 2011, has ended. In that case, given the very close correlation between China’s inflation and global commodity prices, this substantial downward pressure on China’s CPI will also have halted.
The halt to the downward trend in global commodity prices is logical given two factors - that talk in the second half of last year of a double dip US recession, popularised by Nouriel Roubini and others, was exaggerated and that the US Federal Reserve and European Central Bank (ECB) are both engaged in major rounds of quantitative easing (QE) – i.e. printing money. This monetary stimulus is further added to by the financial support the Federal Reserve is giving to the ECB. This new wave of QE has been supporting both bond and share prices and may now be spilling into commodity markets. The partial recovery of gold prices from recent lows is another indicator of the same process. In short upward pressure on commodity prices may well not be temporary.
What conclusions follow?
- International commodity prices need to be very carefully tracked.
- Inflation data not only in China but in other developing economies, notably India and Brazil, needs to be carefully watched to see whether an international effect of a slowing or reversal of the decline in inflation takes place.
- China’s authorities are clearly correct to have taken a relatively cautious approach so far to economic loosening – inflationary pressures may be stronger than generally assumed outside China.
There certainly was a seasonal effect in China’s higher January CPI data. For that reason it is likely China's CPI will fall in February. But nevertheless there is also evidence that the rise in the CPI figure was not only a seasonal holiday effect. As it continues to be the case that international commodity prices, not money supply, shows a close correlation with China’s inflation the data on global commodity prices must be extremely carefully watched to understand trends in China's economy.
Higher international commodity prices, of course, are not due to, or under the control of, China’s economic authorities. But China cannot escape their effect. Both global commodity prices and the inflationary situation in other major developing economies must be carefully followed. While China's inflation is likely to continue to decline from its peak levels there are grounds to consider that China’s, and other countries, CPI will continue to be above market expectations.