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China factory gate inflation threatens to push up consumer prices

PPI increase of 9% in May could squeeze corporate profits and slow growth

Prices for steel, coal, iron ore, copper and other commodities have surged this year, pushing up the PPI.   © Reuters

TOKYO -- The prices of goods leaving factories in China rose at their fastest pace in 13 years, raising concerns that costs will soon be passed onto consumers.

China's producer price index rose 9% in May from a year earlier, faster than the market consensus and the 6.8% increase the previous months, the National Bureau of Statistics reported on Wednesday. The figure is the highest since September 2008.

The higher-than-expected increase was primarily driven by rapid increases in global commodity prices and rising shipping costs recently. The continued recovery of the Chinese economy also contributed to the increase.

Economists warn that manufacturers will face thinner profit margins, and the central bank might have to tighten monetary policy prematurely should the trend leads to a substantial rise in consumer prices.

Dong Lijuan, an economist at the National Bureau of Statistics attributed the higher producer prices to sharp increases in international crude oil, iron ore and other bulk commodity prices, as well as the steady economic recovery of domestic demand in post-pandemic China that month. Seasonality also contributed to the higher growth.

China's PPI has accelerated sharply since the beginning of this year -- from an annual decline of 1.8% in 2020.

Most upstream industries reported higher production costs in May. Prices for the extraction of petroleum and natural gas rose 99.1% from last year, while the costs for smelting and pressing ferrous metals rose 38.1% during the same period.

"The surge in PPI is squeezing profits in downstream industries. But because of strong competition, it won't be easy for firms to pass on the cost increases by raising their own prices," Tommy Wu, an economist at Oxford Economics told Nikkei. Given the weak consumption momentum seen so far this year, he said, it will be difficult to pass prices down to the retail level.

Despite the heftier price tags for goods leaving factories, consumer prices remain stable so far this year. China's consumer price index rose 1.3% year-on-year in May. While the price of pork, a key component of China's CPI, declined 23.8% that month, prices of flight tickets, gasoline and diesel rose 32.3%, 22% and 24.2% respectively.

The rising inflation risks has started to unsettle Beijing. Since May, the government has rolled out a series of measures to rein in the surge of commodity prices, including boosting domestic supply, higher export taxes and clamping down on speculative trading. The measures led to a material price correction of coal, steel and iron ore in late of May, but they recovered somewhat in June partly due to the decline in imports.

"Measures imposed by the Chinese authorities recently will continue to have some impact on reining in prices for commodities and in heavy industry," Wu said. But he noted that global commodity price trends will influence China's PPI inflation.

"For now, we expect many of the global commodity prices will stop rising due to a recovery in supply. China's PPI inflation could peak in the coming months, though it will remain elevated for the rest of the year," he said.

Goldman Sachs played down the potential for producer price inflation spilling over into consumer inflation.

"Headline CPI inflation is likely to stay modest in the coming months. High frequency data suggested year-on-year decline in pork prices widened in early June, and year-on-year inflation in fresh vegetables also moderated," Goldman economists said in a report after the release of the data. "We expect year-on-year PPI inflation to stay elevated in the near term and moderate in the second half of this year."

Citi economists said the rising factory gate prices are a risk to economic growth.

"The rising cost pressures on manufacturers, together with the bumpy recovery of downstream demand, pose downside risks to growth. And widening CPI-PPI gaps would also complicate policymaking," they wrote. "We still think supply-pushed PPI inflation should be better tackled by the NDRC [National Development and Reform Commission]'s targeted measures and won't trigger monetary tightening for now."

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