China: High PPI will delay capacity reduction - ANZ

Analysts at ANZ notes that China’s  Producer Price Index (PPI), rose by 5.5% y/y in December, beating market expectations (4.6%), mainly driven by a price recovery in coal, steel and non-ferrous metals, whose producer prices rose y/y by 34.0%, 35.0%, and 17.1%, respectively.

Key Quotes

“With inflation returning to China, the PPI should remain strong in Q1 2017. A low price base and the government’s enforcement of capacity reduction should lend support to the PPI. However, the index will likely soften in H2 2017 as base effects kick in. We expect the annual PPI to rise by 2.5% in 2017.”

“The strong PPI is unlikely to pass through to downstream sectors this year. Sluggish sub-PPI of consumer goods (0.8% y/y) indicates that the inflation effect transmitted downstream should be limited. The profitability of mid- and downstream producers will be squeezed if rising material prices cannot be transferred to their consumers.”

“However, high commodity prices will delay the government’s efforts to combat over-capacity. Producers are tempted to fire their engines again in the face of rising prices. The government will not fully welcome the rapid recovery of the PPI.”

“Today’s figure suggests that the People’s Bank of China’s (PBoC) policy will focus on bubble prevention and corporate de-leveraging. Nonetheless, given slowing growth and uncertainties in the economy, such as exports and fixed asset investment, we do not think the central bank will start to tighten in H1 2017. They will continue to maintain adequate liquidity levels to prevent a cash crunch. However, high inflation rates will push market interest rates higher. We believe the PBoC will likely increase the size of reverse repos and medium term lending facilities (MLF) before the Spring Festival period in late January.”