While US inflation has climbed to multi-decade highs, with January’s consumer price inflation hitting a 40-year peak of 7.5% year-on-year, inflation in China has sagged: CPI rose by only 0.9% YoY in January, marking the slowest rate across Asia, and producer price inflation is easing quickly too. Indeed, a diverging trend has emerged between inflation in China and the US (Exhibit 1).
In the US, rising inflation has proven more than just transitory. Its persistence and ongoing rise have prompted the Federal Reserve to speed up the timetable for quantitative tightening and interest rate rises.
The latest (January) FOMC meeting minutes, released on 16 February, showed that policymakers were ready to remove monetary accommodation ‘soon’ and the tightening would be undertaken at a faster pace than during the 2015 cycle.
The minutes did not include any signals as to whether a March rate rise would be 25 or 50bp, but the tone was consistent with a ‘nimble’ reaction function, as Chair Powell alluded to recently, with the possibility of rate increases at each of the seven scheduled policy meetings this year.
Against this backdrop, China’s central bank, the People’s Bank of China (PBoC), has been signalling that further policy easing is coming to counter weak growth. The authorities are even tweaking their draconian property market and zero Covid policies to allow for more flexibility in dealing with the slump in growth.
Widest gap in multiple decades
The gap between CPI inflation in China and the US widened to – 6.6% YoY in January, the largest negative monthly disparity since the early 1980s. This highlights policy divergence between the world’s two largest economies.
China has a different inflation dynamic to developed market economies due to the relative strength of its supply chains (as reflected by significantly shorter lead times, Exhibit 2) and the weakness in domestic consumption. Despite Omicron, the resilience of China’s supply chain has helped keep a lid on price pressures.
Chinese equities should benefit from extra liquidity
Falling inflation on the back of weak demand growth is paving the way for more aggressive easing measures in the coming months, despite policy tightening by the US Fed. China’s closed capital account should limit any impact of the policy divergence on the renminbi’s exchange rate. The currency has defied market expectations that a narrowing of the China-US yield spread would weaken it.
Indeed, the PBoC has been intervening in the foreign exchange market in recent months to rein in the renminbi. This intervention is adding liquidity to the Chinese system, augmenting other policy easing measures aimed at boosting growth.
While the US stock market is facing policy tightening in the coming months, China’s stock market seems to be walking into a benign liquidity environment, which should help it to recover.