The recent jump in China’s headline CPI inflation, to a 2.8% one-year average in December has received increasing attention from policymakers. We hold the medium-term view that there is moderate upward pressure on CPI inflation, which will be more realistically reflected in official CPI figures through reweighting the CPI basket and in energy and resource price reforms. However, persistent excess liquidity and its impact on asset prices, rather than higher CPI inflation, will be the more worrying concerns for policymakers. We look for CPI inflation in 2007 to average at a 3% one-year average … An important factor for the jump in headline CPI inflation has been rising food prices (grain prices in particular), which, in our view, is likely a temporary phenomenon … Overall, there are fundamental long-term concerns on food prices, especially considering the decline in arable land, and the growing need for net imports of various agricultural products. However, in the near-term we expect the food price component of CPI to stabilize.
Investors have been asking about the latest uptick in food CPI numbers, which occurred in a number of emerging markets last month. Is this the beginning of a global agricultural inflation boom? … A close look at the Asian data points to two clear findings: first, unlike fuel and mineral prices, food prices are mostly determined by local rather than global market conditions. And second, the biggest potential driver of an agricultural demand boom – China – isn’t anywhere near to hitting the markets yet … Unlike fuels and minerals, China’s food imports are starting at a very low base, both as a share of overall global trade as well as total domestic demand. 2004 was a boom year for Chinese spending on food imports, but for the past two years import volume has been falling outright, with no clear uptrend … The bottom line, as we see it, is that while domestic food inflation should continue to be a dominant theme for individual markets like China, we don’t quite see where a looming regional or global agricultural shock would come from.
The Producer Price Index rose 3.3% year-on-year in January, up from 3.1% in December and last year’s average of 3%, in line with our forecasts. The rise in the PPI is likely to increase pressure for CPI inflation going forward, although the transmission is not immediate and will only be partial. As for implications for the interest rate outlook, consumer price inflation, which will be released [February 14], carries significantly more weight. Official concerns about CPI and asset price inflation have led us to believe that the People’s Bank of China could raise the interest rate by 0.27% in the coming one or two months.
The question for G-7 policy makers is whether currency realignments will temper domestic political concerns in the US and Europe. The answer is an unequivocal no. In the US, the outsize bilateral imbalance is a symptom of an unprecedented shortfall of domestic saving that drove the net national saving rate to historical lows of just 1% over the past 3 years. For the US savings shortfalls create an inherent bias toward chronic trade deficits. America has to import surplus saving from abroad in order to fuel its appetite for growth. The only way to get that foreign capital is to run large current account and trade deficits. China fits all too nicely into that equation. I do not believe a stronger RMB will force Americans to save more. The best Washington can hope for if it relies on such a "remedy" is to shift the China piece of the US multilateral imbalance somewhere else – most likely to a higher-cost producer – which would be the functional equivalent of a tax hike on the American consumer.
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