CPI inflation came in at 7.7% for May, confirming last week’s “leak”, down sharply from 8.5% in April. Both the food and non-food components saw a reduction in inflation with, most importantly, non-food inflation declining from 1.8% in April to 1.7% last month.
This should definitely be good news, but the numbers are not terribly consistent with other information. PPI, of course was up again in May and there are increasing worries and stories about fuel shortages and long lines at gasoline stations. There has been aggressive selling on the part of the government of food reserves and fuel stocks, and many reports of increased scrutiny of price control mechanisms, even with sharp increases in global commodity prices. In addition the earthquake in Sichuan not only interrupted food production (Sichuan is a largely agricultural province) but, more importantly, it interfered with transportation lines though the country. All of this suggests that price increases should continue to be a problem, and a worsening problem, not an improving one.
So I guess I am worried that the reduction in CPI inflation is more apparent than real, and that the “good” numbers will allow the government to believe it has breathing space. If “breathing space” means that they can relax price controls a little, that would be a good thing, but if it means that they decide they are on the right track in terms of monetary policy, they are almost certainly going to be wrong. June numbers might not be too bad, although by then they may include some of the adverse effects of the earthquake, but inflation is definitely spreading – even if part of CPI inflation is disguised as shortages, lower profits, or taxes – and food and fuel reserves need to be replenished. China has little room for another adverse shock. By July or August CPI should be rising again.
The stock market certainly hasn’t taken heart at the “good” CPI numbers. It dropped nearly 100 points within the first two hours of trading and then bounced around that level all day to close at 2958, or 2.2% down for the day. At one point late in the afternoon it traded as low as 2900, before partly bouncing back.
So we have definitely broken the 3000 magic number, and this time for more than a few seconds. What’s next? Today’s South China Morning Post had an article claiming that the government is considering measures to support the market, such as the introduction of futures and margin trading, citing an unidentified person close to the CSRC. I don’t doubt they are considering measures, but I am not sure why either of those particular measures is more likely to push the market up rather than down. If they do announce either, or both, I suspect retail investors may see it as a positive move without really understanding why. In that case I expect they will drive the market up temporarily while more sophisticated investors will sell them whatever they want.
Of course if the government doesn’t do anything for a few days these levels will not hold. Still, they must be worried about how little effect beyond a week or two all of their best previous efforts to hold the market up have had. As I have pointed out on this blog many times, each failure to intervene successfully, of course, undermines their credibility further, and none of their interventions were likely to be successful because none of them have addressed fundamental investor concerns.