What Could Happen After China’s Jan Inflation Report?

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With all the news focused on the coronavirus outbreak, the underlying economic data from China has been slipping a bit under the radar.

Early on Monday, or late on Sunday, depending on where you are, we get the latest CPI figures from the mainland.

This could give us some insight into what we might expect from monetary policy going forward.

Since the end of the Lunar New Year holiday last weekend, the Chinese government and regulators have taken several measures to head off potential negative effects of the virus.

These include further liquidity injections, as well as adjusting reserve requirements. The latter is the Chinese equivalent to monetary easing. But, there is a problem!

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The Trade War Casts a Long Shadow

The inflation rate in China rose slowly all of last year, before starting to spike in October.

That was when it went quite beyond the PBOC’s 3% target. And it’s been at 4.5% for the last couple of months.

That’s an official measure. And it’s subject to a certain amount of uncertainty. With high inflation, the PBOC and the government are constrained in the potential for easing actions they might take.

Traditional economic theory would suggest the central bank would be looking to tighten. But, the Communist Party of China is not all that interested in traditional (capitalist) economic theory.

There has been speculation that the PBOC would raise its target rate to give it more policy room. However, that did not happen. Instead, inflation has stayed constrained at 4.5% for two consecutive months.

Why the Large CPI Rate?

A significant factor in the rise in inflation has implications for Japan, Australia, and New Zealand.

The depreciation of the yuan exchange rate meant that imports increased in cost for Chinese manufacturers and suppliers. And they would eventually pass that on to consumers.

This means it’s harder for Chinese buyers to pay for products denominated in AUD, NZD and JPY, decreasing the demand for those currencies.

This situation could get worse in the short term. The yuan has returned to weakening from the effects of the coronavirus and the expectation of further easing.

This could imply a double impact on inflation, which could have knock-on effects to other major currencies in the Far East.

What We Are Expecting

The consensus among economists is that China’s January CPI increased by 0.6% on a monthly basis, compared to a flat in December.

This would include some of the effects of the coronavirus, which became a news event mid-way through the month.

Expectations are for annualized CPI to repeat December’s month’s 4.5%. Many analysts are suggesting it should be higher, around 4.9%.

While this might have more of an immediate effect on the yuan, the loss of purchasing power among Chinese importers could have an effect on the AUD and NZD going forward.

Both have the potential for rate cuts in the near future, contributing to potential further weakness.

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