China: April CPI Comes In Higher Than Expected

April’s CPI numbers were released earlier today and, as the pessimists among us expected, inflation came in at 8.5% year on year, quite a bit higher than most analysts’ predictions. March’s year-on-year inflation was 8.3%.

Throughout the past two weeks we had been getting a lot of soothing noises about inflation and confident predictions from analysts and even from Governor Zhou of the PBoC that it would come in at 8% or just above – Bloomberg’s poll of 22 analysts predicted on average that year on year CPI inflation for April would be 8.2%. Even Credit Suisse’s Dong Tao, who has normally been very pessimistic – and very right – about inflation, predicted that April’s CPI number would come in at 8% year on year. It took a bitter, twisted guy like Stone & McCarthy’s Logan Wright, who refused to bask in the good feelings and insisted on counting the numbers up for himself, to throw in an 8.5% prediction. He was right, thereby reinforcing my claim a few days ago that for the past six months you would have always done best by betting on the most pessimistic prediction.

Month-on-month inflation rose by 0.1%. This means that inflation for the first four months of the year is running at an annualized 9.9%. At this rate we would need inflation for the next eight months of the year to be 2.4% on an annualized basis to bring us to the government’s 4.8% target for 2008. Clearly this is very unlikely, and even government officials have acknowledged that the official target is intended more for signaling purposes than as a real statement of government intentions.

I assume that most of the investment bank researchers, who are still predicting annual inflation for all of 2008 as coming in between 6% and 7%, will want to reconsider their predictions. With CPI inflation running at an annualized 9.9% for the first four months of 2008, we would need price increases to run at less than an annualized 5.6% for the next eight months if we hope to bring CPI inflation under 7% for 2008. This is not impossible, of course, but it is very unlikely to occur without a significant economic slowdown, so if investment banks are still predicting CPI inflation for 2008 below 7% they should probably revise their GDP growth expectations sharply downwards.

Year on year non-food inflation was the same this month as last month – according to my calculation 2.2%. Commodity, energy, labor, household items and residential property are the main culprits, which unfortunately suggests that inflation is, as expected, spreading away from food. Remember that it is rising food prices that have absorbed inflationary pressures, according to my model of inflation in China, and because food prices have increased so quickly – 22.1% year on year – they have actually forced downward pricing pressure on non-food items. The fact that non-food prices continue nonetheless to rise is, in my opinion, ominous.

Today’s numbers won’t do much to resolve the debate between the pork and money camps. This of us in the money camp will point out that non-food inflation may still be relatively low, but instead of decelerating, it has been accelerating all year. This is wholly inconsistent with the idea that Chinese inflation is just a food problem, since annual price increases of over 21% for food, with food officially 33% of the CPI basket, should have put tremendous downward pressure on non-food prices.

The money camp will also argue that recent foreign currency reserve growth has been way too high and is clearly causing excess monetary expansion, which must show up in overheating and inflation. Finally, they will argue, even with the moderation in export growth, there has been no sign of a slowdown in the economy.

The pork camp will argue that non-food inflation is still low, and we are still seeing the delayed impact of the food supply constraints from last year and during this year’s storm. As long as the government can resist pressures for inflationary expectations to spread, inflation for the rest of the year will continue to drop as the food supply problem eases. They will also point to a slowdown in export growth and continued concerns about weakness in the US economy to insist that the financial authorities have very little room to get it wrong on the side of excess tightening.

We still need to wait and see a few more months of CPI inflation before this debate is fully resolved. I am of two minds as to what the CPI numbers for May and June are likely to be. On the one hand food prices have held up stubbornly but price increases are starting to moderate somewhat and in some cases may even be declining, so we may see some relief there. Thanks to price controls and spending rigidities there may be a lag between a slowdown in food inflation and a pick-up in non-food inflation. From that point of view we may see the CPI index rise only very slowly from its current level, and overall year-on-year CPI inflation hover around 8% to 8.5% for the next month or two, before picking up substantially in the third and fourth quarters as non-food inflation kicks in more aggressively.

Alternatively, with the beginning of the great Olympic party, we may start to see pressure for price increases much earlier. There are already reports of a significant increase in domestic airline tickets, and of course in and around Beijing we are all braced for a big increase in prices – if we haven’t seen them already. There is also pressure for a relaxation of price controls on certain goods because of hoarding, smuggling, and their distorting impacts on consumption. All of this might result in sharper increases in CPI inflation fairly quickly. My worry is that even if we do see a pick-up in inflation in the next two or three months, those who continue to want to postpone the monetary adjustment will argue that the most recent bout of inflation will have been caused by yet another one-off event: the Olympics, which once it is behind us everything will be fine.

The stock markets have behaved a little erratically today. According to my student Shang Ning, who follows the markets closely, the SSE Composite opened around 1.8% below Friday’s close of 3613, and traded further down to 3522 (down 2.5%) a few minutes before the release of the CPI numbers, on expectations that CPI inflation was going to be higher than expected and might result in further tightening action by the PBoC. After the CPI release, however, the market rebounded for the rest of the morning and continued up in the afternoon to close the day up 0.37%, driven by airline manufacturers and steel companies. It seems that bad CPI numbers haven’t really fazed anyone.

Comments

[kelaido]

considering it was not a friendly CPI number, the market did very well today, inching up consistently since the CPI came out. Had it not for the Sichuan earthquake the market would have probably closed much better.

[rlirph]

Considering the severity of this earthquake should we expect a sharp loss in tomorrow's Shanghai Composite Index?

[odin]

Any natural disaster like this is a tragedy and it looks like the toll in terms of life and property will be higher than the first guestimates. However, I dont think it is quite on the order of the 1995 Kobe quake. Chongqing is also inland, away from major export ports so relatively speaking I doubt that the actual damage will be significant.

However, if you try to guess at the sentiment and the impact on the market, you could flip a coin.

[kelaido]

Overnight news reports are indicating serious damages and casualties. 6 power plants out of commission. Current death toll of 8600 will only increase drastically once rescue teams reach the epicentre. Sichuan is a major food producing centre for the southwest. We can count on the disruptions and destruction exerting more pressure on CPI. Bad news on top of very very bad news...

[weng ho teng]

Great article.

I am high on China internet stocks at present. The earnings have been tremendous across the board so far in the sector.

My top pick at present is MYST.OB. They are at the nexus of several of the hottest areas of the internet in Asia.