Chinese Inflation in the Hands of the PBoC?

Last Tuesday the markets received a double whammy of bad news from China with a couple of not-so-impressive manufacturing PMI reports for February. The HSBC/Markit Manufacturing PMI dropped to a 7-month low of 51.7. Falling from 54.5 in January, it is the biggest decline we’ve seen since the study was started in 2004! Meanwhile, the China Federation of Logistic sand Purchasing (CFLP) PMI also showed that manufacturing activity growth slowed to an index number of 52.2 after coming in at 52.9 in the month prior.

By the looks of these figures, I would say that the People’s Bank of China (PBoC) is doing a pretty good job at tightening their economy!

If you’ve been living in your parents’ basement just playing Xbox all day, you should know that central banks usually fight off rapid economic growth by raising its interest rates and even obliging banks to keep more money in their reserves in the form of reserve requirement ratio (RRR). These policies usually make it difficult for markets to access more moolah, which would dampen spending and investment in the economy.

In China’s case, the PBoC has already raised the RRR more times than Big Pippin fixes his afro on a daily basis, with the RRR now standing at a record high 19.5%! In addition, the PBoC has also raised its benchmark interest rates twice in just over a month to 6.06%, just to cool down the economy’s rapid growth! With aggressive policies like that, who would doubt the PBoC’s determination to limit inflationary pressures?

Still, I’ve got a feeling that inflation is gonna be like a monkey on China’s back and won’t leave just like that.

Again, if you’ve been hungover the past couple months (I wouldn’t put it past you if you spent New Years with Pipcrawler), lemme remind you that recent CPI readings show that consumer prices rose by 4.9% last January, even faster than December’s rise of 4.6%. And chances are that we’ll see this figure continue to rise in the coming months.

For one, while both manufacturing indices are lower than their long-term averages, let’s not forget that both are still ABOVE 50, the baseline number that separates expansion from contraction. This means that manufacturing is STILL growing. Also take note that these figures are seasonal. Data show that February is typically a weak month because the economy takes a chill pill during Chinese New Year.

Digging deeper into the reports, I noticed that input prices increased at a faster pace than output prices, hinting that the dampened outlook of manufacturers might have been because of rising commodity prices.

Despite this, it’s also important to note that both figures still rose. This indicates that inflation is still present and that it was probably just profit margins that took a hit last month.

If the PBoC wants to mute inflation, then perhaps hiking rates and reserve requirements is indeed the best way to go.

Remember, one reason why inflation is on fire is because of the sharp rise in commodity prices. Rising prices leads to higher input prices, which is another side of inflation. Also, take note that it is also because of persistent Chinese demand that commodities have been on the rise.

With all that said, I can see why the PBoC is looking to continue to hike rates. Slowing down growth via controlling money supply could have the dual effect of not only slowing down demand, but tempering the rise in commodity prices as well.

So it seems that the destiny of Chinese inflation is in the hands of the PBoC. The question is, are they up to the task?