Better watch on prices key to economic stability

Three variables－pork prices, energy prices and the overall growth rate of food prices－will be the key elements impacting the consumer price index in China in the second half.

First of all, food and energy prices are mainly responsible for CPI ups and downs. Oil prices are definitely of great importance to industrial companies.

Pork prices, which have a longer cycle and usually feature larger fluctuations, make bigger contributions to CPI shifts.

Wholesale pork prices surged 20 percent in the first eight days of July, approaching 29 yuan ($4.3) per kilogram on July 8 and far exceeding market expectations. Market administrators have been closely watching the price changes, saying that they will release pork reserves when appropriate to prevent prices of the staple meat from rising too rapidly.

In addition, food prices have remained at a high level worldwide due to the global food crisis. The Chinese market has thus paid close attention to imported food price inflation.

Under the benchmark scenario, pork prices are set at 30 yuan per kg, oil prices at $110 per barrel and the annual growth rate of food prices at 4 percent.

Pork prices are projected to be around 25 yuan per kg under optimistic estimations and 40 yuan under pessimistic estimations if supplies contract due to floods or swine fever.

As for oil prices, the relatively smaller global oil supply may have some negative impact. There is little room to release more oil based on current indicators. This is mainly due to contracted capital expenditure over the past decade. Although overseas demand for oil has marginally decreased, we should not be overly pessimistic as continued economic recovery in China can be anticipated.

Therefore, the optimistic forecast for oil prices is around $90 per barrel while the pessimistic prediction is $130 per barrel.

Then come food prices. Domestic food prices have remained stable over the past few years with the annual growth rate coming in at around 2 percent. Given the special situations seen this year, the benchmark food CPI is likely to be around 4 percent in the next 12 months, and 7 percent under the worst-case scenario.

To sum up, the CPI will peak at 3.2 percent in China in the second half under benchmark scenarios, with pork prices likely to make the biggest difference. This reading is stable if compared to the 8 percent CPI expansion widely found in overseas markets.

Under the worst-case scenario, China may see its CPI top 4.7 percent in the next few months of the year if oil prices and pork prices further swing up. But that can still be considered mild if compared to the double-digit CPI spike in the United States or major European economies. But sentiment in the Chinese capital market and risk appetite will be somehow impaired if the CPI exceeds 4 percent.

The CPI in the US and major economies of the eurozone surged more than 8 percent in May year-on-year. The situation further deteriorated in the eurozone in June.

In contrast to jarring CPI data elsewhere, inflation is so much better contained in China, with the CPI only up 2 percent on a yearly basis in May.

At present, much concern is laid on the stability of inflation levels in China, which are also a key variable to market performance. If pressure from inflation accumulates faster than expected, less room will be left to maneuver the monetary policy, thus dragging down growth. The stock market, which is largely driven by relaxed policies, will be hit hard under such circumstances. In other words, if inflation is better controlled, policies will be made more flexibly and China's advantages will be more noticeable when the rest of the world is wrestling with soaring inflation numbers.

China's CPI rose 2.5 percent year-on-year in June, slightly above the 2.4 percent market estimate and higher than the 2.1 percent year-on-year growth recorded in May.

The country's PPI jumped 6.1 percent on a yearly basis in June, moderately higher than the 6 percent market expectation but down from 6.4 percent seen in May.

The carry-over effect of last year's price changes accounted for 1.2 percentage points of CPI growth last month, up 0.4 percentage point from a month earlier and serving as the major cause of the CPI increase in June.

This is mainly due to the continued decline of pork prices during the first half of last year, with a monthly drop of over 15 percent in June 2021. As a result, the food CPI increased 2.9 percent year-on-year in June this year, up 0.6 percentage point from a month earlier. The rise in food CPI has contributed to the rising CPI in general last month.

Given that pork prices continued to fall between July and October last year, the low base readings will further push up the CPI number in the next three months.

If measured on a monthly basis, the CPI remained flat in June. Specifically, the food CPI dropped 1.6 percent from a month earlier, with contraction further expanding 0.3 percentage point month-on-month. The declining prices of fresh vegetables were the major reason for the contraction. Amid better supplies and improving logistics efficiency, vegetable prices slumped 9.2 percent month-on-month in June. Vegetable prices may rebound in light of their seasonal characteristics. But given the relatively higher base readings last year, vegetable prices will continue to fall on a yearly basis.

Nonfood prices climbed an average 0.4 percent in June year-on-year, up by 0.3 percentage point compared to data collected in May. The surge in energy prices has been quite noticeable. Due to rising global oil prices, petrol and diesel oil prices jumped 6.7 percent and 7.2 percent, respectively, in June on a yearly basis, up by 6.1 percentage points and 6.6 percentage points, respectively, from that in May.

Meanwhile, services and consumption have gradually recovered as the COVID-19 control policies are further optimized. Air tickets saw prices soar 19.2 percent on average in June and that for travel packages up 1.2 percent, with the increase rate up 15 percentage points and 0.8 percentage point, respectively.

China still faces much pressure in terms of endogenous deflation, which is mainly due to the inadequate economic driving force. The relatively smaller market demand will suppress inflation and result in weaker core CPI readings.

The trend of declining core CPI numbers has been increasingly noticeable ever since October 2021.The indicator stands around 1 percent at present, which is lower than the 1.5 percent level prior to the pandemic in 2019. The core CPI will remain at 1 percent in the second half of this year.

The declining PPI and losses reported by industrial companies have also reflected the pressure of endogenous deflation amid the downward economic trend. Prices of production materials, including steel, copper and aluminum, have contracted significantly. Recovery of the property market, which has not met market expectations, is one major cause.

The government should be prepared. Overall demand should be boosted to maintain China's economic growth rate within a reasonable range. Supply elasticity should also be improved, including securing energy supplies. In this way, companies in the upper stream of the industrial chain can work to their maximum capacity and help curb inflation.

The writer is chief economist of financial services provider China Renaissance. The article was first published on the official WeChat account of the China Chief Economist Forum, to which the author also serves as a director.

The views don't necessarily reflect those of China Daily.