PPI in China has swung from deflation to relatively high inflation over the last 6 months.
Wholesale prices are rising fast, import prices are also rising due to the lagged effects from
a weaker yuan are moving sharply higher. (CPI, especially core CPI, had been rising pretty fast too, although the figure for February saw a large slump, driven in part by base effects. PPI in February kept rising.) Some inflation is desired, not least to help ease the debt-deflationary dynamic, but too much inflation is problematic, both for China and the rest of the world.
If China begins to export significant amounts of inflation then this would cause US yields
to rise, worsening capital flight from China, leading to a fall in domestic liquidity and thus
growth, setting in chain the likelihood of yet more capital flight. We are seeing some
monetary tightening in China – money growth is now rolling over – so this may nip inflation in the bud before it becomes unconstrained (although history is littered with examples of rising inflation becoming out-of-control heart-stoppingly quickly). Also base effects will start kicking in soon so this may take some of the upward pressure off.
Nevertheless, in the short term, inflation looks to be headed higher. Citi’s Inflation Surprise Index for China leads PPI by about 3 months (left chart – please click on image to enlarge). Rising inflation, combined with slowing money growth, is squeezing excess liquidity in China lower, which removes a support for Chinese equity prices and the property market (right chart).