CPI came in lower than expected, but the market still isn’t happy

CPI inflation numbers were just released by the National Bureau of Statistics. As expected, they showed a continued decline in the year-on-year CPI inflation, although at 6.3% the figure was better than market expectations of 6.5%. Given the trajectory of food prices so far this month CPI inflation for August could fall below 6%. On average prices in July rose 0.1% month on month.

This is great news, but it is not unambiguously good. The non-food component of CPI rose from 1.9% year on year in June to 2.1% in July, so although it is low, it is rising – not a good sign, in my opinion. We are also hearing more and power about power shortages and rationing outside the Olympic-blessed city of Beijing. World fuel prices may be declining, but they are still substantially higher than they are in China, thanks to price freezes. This can’t help but put continued upward pressure on the cost of energy.

So now we’re caught in the bind that I discussed yesterday. Declining CPI inflation will encourage those policy-makers who are mostly worried about slowing growth to insist that China back away from the various monetary and credit tightening measures it had tried to impose over the past nine months. High and rising PPI inflation will strengthen the concerns of those who think China’s main risk is from excessive monetary expansion.

Nothing has really changed to shift the argument decisively in one direction or the other, and I suspect we will continue to see tentative policy moves in both directions. The most amount of effort – or at least visible effort – seems to be that expended on tightening capital controls, but it is hard to know what this portends. If the capital controls are very successful – and I am doubtful they will be – it might create breathing space and give the authorities reason to speed up RMB appreciation again, with the controls preventing an accompanying surge in speculative inflows. If not, it puts greater pressure on them to regain control of monetary policy via a one-off maxi-revaluation. Either way I still think China cannot resolve its current imbalances without a significant currency adjustment.

As for the stock market, at first it seemed pretty unambiguously in favor of the CPI data which, among other things, suggested that the authorities are more likely to be inclined to relax the “tightening” measures. After a very bad opening that left the SSE Composite down by a little more than 1.5%, the mid-morning release of CPI data turned the market around sharply, so that by lunch it had regained all it had lost, plus an extra 0.2%.

But the happiness didn’t last. Perhaps there were rising worries that the huge gap between PPI and CPI inflations would hurt corporate profits, or perhaps investors are just to depressed to enjoy a rally (worrying, among other things, about unrest in Xinjiang province, where the death toll over the last week is up to 31), but immediately after lunch after a quick 7-point jump in the first five minutes the market suddenly lost its legs and began sliding. It bounced around all afternoon, with the SSE Composite ending the day at 2457, just over half a percent below Monday’s close.

I think it is going to take a major effort to get this market to regain confidence, but even with a major government intervention I think there may be more bad news on the earnings front. Today’s Emerging Markets Economics Daily (produced by the research guys at Credit Suisse) has this to say about car sales:

Total vehicle sales growth in China moderated sharply in July to 4% yoy. According to the China Association of Automobile Manufacturers, sales of commercial vehicles contracted 3% yoy in July (to 177,600 units), the first contraction since January 2006. Passenger vehicles sales managed to maintain 7% yoy growth (to 488,200 units), but this was the first single digit growth since August 2006. The data reflect weakened domestic demand in China.

Credit Suisse goes on the say that their equity analyst, Michele Mak, believes commercial vehicle sales will slow even more dramatically over the rest of they year.

Three weeks ago on my blog I cited a Bloomberg article that said that “China’s stockpile of unsold new vehicles rose about 50 percent in the six months ended June, hitting a four-year high, as automakers expanded production and sales growth slowed.” In the article some commentators brushed off the rise in inventory saying that they were expecting a surge in car buying later in the year. If it doesn’t happen, I suppose we will necessarily see rapidly rising car inventories. Rising inventories is one of the main warning signals we have to watch for as evidence that the over-investment cycle is finally about to end.

Originally published at China financial markets and reproduced here with the author’s permission.