China’s inflation makes it harder for the PBOC to lower interest rates, the US Fed

Transport fuel prices rose by 24.1% in China in March 2022 from a year ago, the largest increase in the country’s consumer price index.

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BEIJING – Sustained inflation in China narrows the window for when the People’s Bank of China can lower interest rates and support growth, economists said.

Official targets for producer and consumer prices in China rose in March by more than analysts expected, according to data released on Monday.

“Rising food and energy price inflation is limiting the room for the PBoC to lower interest rates despite the rapidly deteriorating economy,” Nomura’s Chinese chief economist Ting Lu and a team said in a note on Monday.

Lu referred to his team’s report earlier this month, which noted how China’s 1-year benchmark deposit rate is only slightly above the rate of increase in consumer prices. It reduces the relative value of Chinese bank deposits.

At the international level, higher US yields narrow the gap between the benchmark US 10-year government yield and its Chinese counterpart, reducing the relative attractiveness of Chinese bonds. Lowering interest rates in China would further reduce this gap.

Interest rates on China’s 10-year government bond fell for the first time in 12 years below the US for the first time in 12 years, according to Reuters. In the past, Chinese bond yields tended to trade at a premium of 100 to 200 basis points to the US

“We believe that April may be China’s last chance to get a short-term interest rate cut sooner [the] The Fed’s potential balance sheet is shrinking, “said Bruce Pang, head of macro and strategy research at China Renaissance.

The Fed meeting minutes released last week showed how policy makers generally agreed to reduce the central bank’s holdings of bonds, likely from May to around double the price before the pandemic. US consumer price data is released overnight.

“Rising inflation, if [it] continues, may further limit China’s room for maneuver to political maneuvers, “Pang said.

He noted how Chinese investors are increasingly expecting the PBOC to act on top government comments this month.

China will adjust monetary policy “when appropriate” to support growth, Prime Minister Li Keqiang told a cabinet meeting last week.

Profit margin squeeze

The producer price index rose by 8.3% in March, slower than the rise of 8.8% in February and the lowest since April 2021 according to wind data. Coal and oil products contributed some of the biggest gains.

Within the consumer price index, the largest increase was in fuel for transport, an increase of 24.1% year-on-year in March. Global oil prices have risen since the war between Russia and Ukraine began in late February.

China’s consumer price index rose 1.5% in March, up from 0.9% in February, and the fastest since consumer prices rose at the same pace in December, wind data showed. A sharp drop of 41.4% year-on-year in pork prices continued to pull down food inflation. Vegetable prices rose by 17.2 per cent.

“China’s inflation dynamics put continued margin pressure on Chinese companies,” said Bruce Liu, Beijing-based CEO of Esoterica Capital, an asset manager.

“March inflation was not the only force that lowered Chinese stock markets [on Monday]and the rising real interest rate-induced stock sales last Friday in the US spilled out, “Liu said.” Several Covid concerns in several places outside Shanghai (Guangzhou, Beijing, etc.) also weighed on market sentiment, and investors have their hands full at the moment. “

The US 10-year government bond yield rose to a three-year high on Friday and rose further overnight on Monday to 2.793%, the highest since January 2019. China’s 10-year government bond yield held around 2.8075% on Tuesday, according to Wind Information.

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Citi analysts expect the PBOC to lower at least one key interest rate or reserve ratio as early as this month – a measure of how much cash banks need to have on hand. They said the extended omicron wave requires more monetary easing.

“Inflation will not limit monetary policy for now, in our view,” analysts said, “but could become more of a source of concern in the second half.”

They expect the producer price index to decline due to last year’s high base – to an annual increase of 5.6% – while the consumer price index is likely to rise slightly – with an increase of 2.3% for the year – as food prices remain high.

– CNBC’s Chris Hayes contributed to this report.

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