Despite an acceleration in Chinese inflation, Morgan Stanley remains confident that the Chinese government has longer-term inflation expectations under control.
Morgan Stanley’s Qing Wang:
Inflation rebounding in April: Following the release of weekly price data on April 25, we forecast headline CPI inflation to bounce back to +2.8%Y in April from +2.4%Y in March, translating into sequential growth of +0.3%M (versus -0.7%M in March). The higher inflation is mainly attributable to food inflation, which we expect to accelerate. The momentum of upstream inflation should remain strong, intensifying to +6.5%Y (versus +5.4%Y in March). We expect the carryover effect of CPI inflation to rise to 1.3% in April (versus 1.1% in March), and that of PPI inflation to edge down to 4.1% in April from 4.2% in March.
The chart below shows how inflation expectations in the Chinese bond market have actually been in a moderate down-trend since December 2009. They’ll need to keep this up given Morgan Stanley’s expectations of accelerating inflation.
After two RRR hikes, one in January and one in February, the PBoC has remained subdued, but it is not resting. In fact, the PBoC is working hard to withdraw the excessive liquidity released last year to cushion the economic hard-landing. After nine weeks of consecutive net withdrawal, the PBoC has drained around Rmb1 trillion of liquidity, equivalent to three 50bp RRR hikes. In this context, inflation expectations have remained tame.
We expect the PBoC to continue such quantitative tightening in the coming months, postponing the timing of interest rate hikes to adapt to the pace of the renminbi exchange rate reform. In light of the extraordinarily aggressive open-market operation (OMO), market participants are concerned that market liquidity may become stretched if this large-scale OMO continues. In our view, such worries are unwarranted, as the reference yield of the 1-year central bank bills has remained unchanged at 1.9264% since January, regardless of the massive net withdrawal seen.
(Via Morgan Stanley, China: Inflation rebounding in April, Qing Wang, 28 April 2010)
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