China released updated inflation figures for December earlier today, with producer price inflation surging to a more than five-year high while consumer price inflation moderated.
According to Wei Li, China and Asia economist at the Commonwealth Bank, the result is as close to a Goldilocks scenario as one can get as the Chinese economy heads into 2017, laying the foundation for a pickup in industrial profitability and investment on one hand while allowing monetary policy to remain relatively loose, assisting the nation’s economic transition.
“Rising producer prices have led to improving industrial profits, which should translate into higher investment overtime,” says Li.
“Industrial recoveries will also help China to better cope with a mild housing downturn, and therefore supportive of the CBA’s higher-than-consensus GDP growth forecast of 6.8% for 2017.”
The chart below, supplied by the Commonwealth Bank, shows the relationship between Chinese producer price inflation, industrial profits and investment:
While downstream price pressures are clearly building, Li suggests that based on historic evidence, the pass-through to consumer prices is usually limited in scale, something he believes will allow China’s central bank, the PBOC, to focus on other more pressing issues for the Chinese economy in the year ahead.
“The pass-through effect from the PPI to the CPI has been limited in the past,” he says. “Our calculation indicates the rise in PPI inflation in H1 2017 should add no more than 0.5ppts [percentage points] to China’s CPI inflation in 2017.”
“It allows the PBOC to focus on other more pressing issues for now, such as managing market expectations on the path of the CNY [Chinese yuan] in 2017.”
Li is forecasting that producer prices will increase by 4.2% in 2017, near double the pace he sees for consumer prices at 2.2%.