Mind the gap

Inflation: still not felt here?

“We now have the worst of both worlds – not just inflation on the one side or stagnation on the other side, but both of them together. We have a sort of ‘stagflation’ situation.”

Such was the verdict of Iain Macleod, a British politician, who introduced the term stagflation in 1965, although it wouldn’t be more widely used until the energy crisis of the mid-1970s.

Higher energy prices mean that the threat of stagflation is getting mention again this autumn in China. And although the latest GDP numbers on Monday hardly point to stagnation, they do signal a sudden slowdown in the Chinese economy at a time when producer prices are surging at a record pace.

China’s economy grew just 4.9% in the third quarter, compared with a 7.9% gain in the three months to June. The growth rate was the slowest for a year and well below the pre-pandemic target of 6%, with commentators blaming summer outbreaks of Covid-19, energy shortages (see WiC559), disruptions to international shipping (see WiC555), and a brewing crisis in the property sector triggered by Evergrande’s fight for survival.

Industrial production lost steam in particular because of power and output reductions (partly the result of new controls over energy consumption motivated by green policies). Fixed asset investment fell sharply as well on declining confidence in the property sector, where developers have been struggling with a credit squeeze and sales of new homes have dropped steeply.

The government is already working on measures to cushion the slowdown over the remainder of the year, with a fine-tuning of credit policies in the property market and a push to boost coal production. But in the meantime, some of the strains have been rising to the surface, especially in factory gate inflation (PPI), which climbed 10.7% in September, the fastest growth on official record. Analysts have put the blame on rising prices for coal, gas and a mix of products that demand a lot of energy, like aluminium.

But there isn’t much sign that businesses are passing the burden on to shoppers. Headline inflation for consumers (CPI) declined slightly to 0.7% in the same period, primarily because of a fall in food prices.

However, at 10 percentage points, the gap between PPI and CPI is now the widest in many years.

Given China is the world’s largest exporter, factory gate inflation could still feed through into higher prices in international markets. There was scrutiny of prices for the goods at the 130th gathering of the Canton Fair, which concluded on Tuesday. The anecdotal evidence was that some increases were being reported, although they weren’t enough to crimp export orders.

The latest Chinese manufacturing data on profit margins suggests that many businesses can absorb some increases in costs without incurring losses. The typical margin in August was still 6.6%, for instance, and companies will hope to protect their bottom lines as stronger sales accompany the recovery from the pandemic.

Subdued consumer prices gives the central bank more room to buoy the economy, although policymakers will be wary about loosening too much and stoking PPI further. Sun Guofeng, the head of the PBoC’s monetary department, still sounded confident last Friday in telling reporters that inflation risks were “controllable”, even in a situation in which factory gate prices are frothy until the end of the year.

There’s speculation too that the central bank could choose to relax reserve ratio requirements in the fourth quarter, supporting a new wave of lending. “We don’t need to worry about whether releasing more money will push inflation higher because we still have room,” Yao Jingyuan, a senior researcher at the Counsellor’s Office of the State Council told reporters on Monday, according to a transcript cited by Bloomberg. Consumer inflation is likely to be 1% for the full year, Yao added.

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