Why China’s central bank is unlikely to cave in to inflation pressure from the commodities boom

For emerging markets, the inflation jump, while temporary, could put public pressure on central banks to raise interest rates
But Chinese policymakers see the commodity price surge as driven more by external factors, which cannot be directly mitigated by domestic policy tightening

Sylvia Sheng

Published: 2:30pm, 21 May 2021

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Commodity prices, which had returned to pre-coronavirus levels by the end of last year, have gone on to rise by more than 20 per cent this year, according to the Commodity Research Bureau Index. The increase has been broad-based, affecting energy, industrial metals and agricultural prices.

In particular, iron ore and copper prices have surged to all-time highs, passing key levels of US$200 and US$10,000 per tonne respectively. The rapid price surges were driven by booming demand as the global economy recovered while supply remain constrained.

These higher commodity prices are already showing in the latest inflation signals. Consumer price indices have picked up across emerging markets since the start of the year.

Inflationary pressure from rising commodity prices is likely to be more of a concern for the central banks of emerging rather than developed markets, as inflation expectations tend to be less anchored in emerging economies.

Benign inflation since the start of the Covid-19 pandemic has enabled many emerging-market central banks to ease monetary policy significantly, in contrast to the policy tightening seen in previous crises.

BHP Billiton's Mount Newman iron ore mine in Western Australia is pictured in 2010. Iron ore and copper prices have surged to record highs this year. Photo: AFP/BHP Billiton

But as inflationary pressure rises, there is a greater risk of policy tightening, which could affect the economic recoveries of some of the higher-performing emerging markets.

Given the amount of spare capacity in most emerging-market economies outside Asia, emerging markets as a whole do not seem too vulnerable to broad-based inflationary risks. But the general public perception may be different.

Higher commodity prices, especially compared to last year’s unusually depressed levels due to the pandemic, could make it look as if inflation in emerging markets is rising sharply. This jump should only be temporary, as the base effect eases later this year, but it could still feed into expectations of higher inflation.

This is especially a worry for central banks with more challenged inflation-targeting credibility – it could force them to tighten policy earlier than expected. Indeed, we have already seen interest rate increases in Russia and Brazil as headline inflation rates breached the upper boundary of official targets.

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China is better positioned than other emerging markets and is unlikely to tighten its monetary policy in response to rising commodity prices.

Higher raw material prices pushed up China’s producer price index (PPI) by 6.8 per cent in April, its biggest year-on-year jump in years. But consumer inflation remained muted with the core consumer price index (CPI), which excludes food and energy, rising just 0.7 per cent year on year in April.

Past experience in 2010 and 2017, when the PPI also rose above 6 per cent, suggests that Chinese policymakers tend to focus more on consumer prices when it comes to interest rate decisions. In both episodes, the People’s Bank of China only started to raise rates when the core CPI began to rise steadily.

Prices of services could go up as people consume more, especially in travel and tourism, which could drive up the CPI. But the index increase is likely to remain below the PBOC’s 3 per cent ceiling this year, as higher producer prices have not historically trickled down to consumers.

More importantly, Chinese policymakers see the recent spike in commodity prices as driven more by external factors, which cannot be directly mitigated by domestic monetary policy tightening.

In the PBOC’s first-quarter monetary policy report, it attributed higher commodity prices to: strong policy stimulus in major developed economies amid improving global demand; supply-side constraints due to the Covid-19 resurgence; and ample global liquidity due to easy monetary policy.

With the expectation that inflation will stabilise over time, the PBOC is poised to ignore any short-term spikes.

While interest rate rises are unlikely in China this year, gradual monetary tightening is likely, in the form of slower credit growth and more industry-specific regulations. Recent measures such as the antitrust and fintech regulation and credit cleanups signal a shift of policy focus towards addressing long-term structural problems and containing financial risks in the system.

The Politburo meeting on April 30 confirmed that policymakers see 2021 as a window of opportunity to promote structural reforms. At the same time, officials know that economic recovery is still uneven and stressed the need for policy stability and continuity, which should cap any aggressive policy tightening.

Sylvia Sheng is a global multi-asset strategist at JP Morgan Asset Management

This article appeared in the South China Morning Post print edition as: China to ride out commodity price surge without tightening

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