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China Inflation Fuels Rate-Cut Calls as World Starts to Tighten

·4 min read

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China’s inflation pressures moderated in December, giving the central bank scope to cut interest rates to cushion the economy’s downturn just as most major nations look to tighten policy.

The producer price index rose 10.3% from a year earlier, down from November’s 12.9%, while the consumer price index increased 1.5%, compared with 2.3% in November. Both came in lower than economists expected.

The inflation surprise adds further impetus to calls for the central bank’s first cut in its key policy interest rate since April 2020, possibly as early as next week. Authorities have shifted to a more pro-growth bias this year as a property market slump and repeated virus outbreaks threaten the outlook.

Read More: Goldman Lowers China 2022 Growth Forecast to 4.3% on Omicron

“The probability of a rate cut in the first quarter is high, and the closest window is this month,” said Bruce Pang, head of macro and strategy research at China Renaissance Securities Hong Kong Ltd. Consumer inflation “will not be a concern in 2022” and the core measure, which strips out volatile food and energy costs, will stay muted below 1.5%, he said.

The People’s Bank of China could lower the cost of medium-term loans -- a key policy rate -- as soon as next week, according to Scotiabank currency strategist Qi Gao. He predicts a 5 to 10-basis point reduction from 2.95%. Australia & New Zealand Banking Group, Goldman Sachs Group Inc., BNP Paribas SA and DBS Bank Ltd. have also flagged the chance of a cut soon.

The central bank has already freed up cheap long-term funding for banks, while the government has brought forward debt sales in an attempt to speed up fiscal spending.

What Bloomberg Economics Says...

The takeaway from the December retreat in China’s factory-gate and consumer price inflation: the central bank can rest easy if -- as we expect -- it adds more stimulus to support the economy. Producer price inflation eased for a second consecutive month, while consumer price inflation dropped back below 2%.

Eric Zhu, China economist

For the full report, click here.

A rate cut would put the PBOC on a divergent path with the U.S. Federal Reserve, which is expected to start hiking interest rates to curb the strongest inflation in four decades. Data due on Wednesday will probably show that U.S. consumer prices rose 7% in December from a year earlier, according to the median forecast of economists surveyed by Bloomberg.

China’s government has taken a number of measures recently to curb surging factory-gate inflation, boosting supplies of key commodities and cracking down on speculation. There are signs the steps could be having a desired effect.

Consumer inflation also remains subdued, largely because of the outsized effect of falling pork costs. Food prices fell in December, with pork prices dropping almost 37% and vegetable price gains slowing.

The spread of omicron-variant virus cases in China remains a cloud over the inflation outlook. China is the world’s biggest producer and consumer of raw materials, and if outbreaks continue to spread and prompt more lockdowns, some supply-side disruptions could ensue. The upcoming Lunar New Year holidays will also see a surge in demand for staple foods and possibly higher prices.

Read More: Global Supply Chains Brace for Impact as Omicron Reaches China

“Lower inflation opens room for the government to loosen monetary policies further,” said Zhang Zhiwei, chief economist at Pinpoint Asset Management Ltd. “The recent Covid outbreaks in some Chinese cities impose further downside risks to the economy. The pressure on the government is rising.”

The PBOC could trim the cost of 7-day repos -- a shorter-term interest rate -- as soon as Friday, according to Li Chao, an analyst at Chinese brokerage Zheshang Securities Co., and then follow with cuts to the 14-day repo and MLF rates on Jan. 17.

China’s tech-heavy ChiNext Index rose as much as 2.4% after the inflation data was released, it’s steepest gain since Nov. 22. The gauge had been falling every day since the new year.

For the full year, factory gate prices rose 8.1%, while consumer prices increased 0.9%. Economists expect consumer prices to grow 2.2% in 2022, and factory-gate prices to gain 4% for the full year, according to the median estimates in a Bloomberg survey.

Other key highlights of the data:

  • Core CPI rose 1.2%, the same as in November

  • Hotel and accommodation prices fell 0.8% month-on-month as virus outbreaks curbed travel

  • Services inflation was 1.5% in December, unchanged from the previous month

  • Non-food prices increased 2.1%, while food prices fell 1.2%. Prices of fuels used in transportation surged 22.5% year-on-year, the biggest jump among non-food categories

(Updates with expectations for Fed rate hikes.)

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