China: RRR cut in sight as inflation fears ease

China’s easing to provide financial support for its economy amidst Fed taper talks should weigh on the yuan exchange rate.
Nathan Chow09 Jul 2021
  • Factory-gate price inflation may have peaked
  • Falling hog prices, stable housing rents and utilities costs will keep CPI inflation at bay
  • State Council hinted at RRR cut to help bolster the economy as inflation concerns dissipate
  • Implications for investors: Yuan weakens as the proposed cut contrasts with Fed talk of taper…
  • … CGB yields to fall amid more financial support for the economy
Photo credit: AFP Photo

PPI peaked

Take iron ore, one of the biggest gainers among commodities this year. It has fallen more than 8% since May’s peak alongside other key raw materials. Similar trends were evident in the midstream spectrum, with price gains of copper and rebar slowing from recent high.

The retreat can be attributed to the government’s efforts to rein in high-flying input prices. Domestic firms, including steel mills, commodities merchants and brokerages, were requested to reduce bullish bets on local futures markets for highly volatile raw materials. State-owned enterprises were also ordered to control risks and limit their exposure to overseas commodities markets. Drawdown of strategic stockpiles by the Reserve Bureau also helped. All these will continue to weigh on the prices of commodities.

Limited pass-through

CPI inflation held steady at only 1.1% in June, a sign of a limited pass-through of factory-gate prices to consumers. Food inflation, which accounts for around 20% in the CPI basket, remained in check. Vegetable prices declined further in the first week of July. Pork prices fell deeper into deflation territory on recovering pig stocks in 2H. Housing rents and utilities also helped stabilized CPI. The former picked up by 0.7% last month and was still below pre-pandemic levels, while government controls limited rises in utility prices.

Transmission has weakened since 2013

Intense competition aside, an increase in the weight of services in the CPI basket softened services prices to 1.0% in June from an average 1.7% in 2019. A recovery in household consumption amid stunning vaccine surge could spur gains in service prices and headline CPI in the coming months (i.e. catering, travel, and entertainment). Even so, the process will be gradual and moderate, as evidenced by the still low core CPI reading. Clouding the outlook is the softness in household spending power. Real income per capita growth of 4.9% in 1Q21 (2-year average growth) was still 1.9%ppt off the 1Q19 level.

“Pro-growth” shift

Against such a backdrop, PBOC will likely keep LPR steady as the commodity cycle plays out. Meantime, we reiterate our view that the authority may step up liquidity injections in Q3 amid concerns over the faltering recovery and looming municipal bond supply. (see “China: Inflation and monetary policy outlook”, 27 May).

Echoing our call is the statement released Wednesday by State Council’s executive meeting chaired by Premier Li Keqiang – “authorities should use monetary policy tools, including lowering the reserve requirement ratio, at an appropriate time to support the economy”. Arguably, State Council’s shift suggested subdued Q2 activities in next week’s data releases. A reduction in the RRR for the first time since mid-2020 could lower CGB yields. China’s easing to provide financial support for its economy amidst Fed taper talks should weigh on the yuan exchange rate.

To read the full report, click here to Download the PDF.

Nathan Chow 周洪禮

Senior Economist/Strategist 策略師 - 中國及香港

Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.

The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation.  Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.  The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation.  The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.

This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.

DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. 

DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability.  18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.

DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability.  13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR

Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply.  The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.