Introduction: Where are the new hotspots in the financial market?
Introduction: Since the end of last year, global inflation has begun to soar significantly. In February this year, the year-on-year growth rates of PCE prices in the United States and CPI in the Eurozone both exceeded 2%. The goals that major central banks have been striving for over so many years by implementing loose monetary policies were suddenly achieved within a few months, and global reflation expectations have soared. But at that time, we pointed out that “whose fault is global inflation? It’s all the oil price’s fault”, believing that the rebound in inflation would be difficult to sustain. Several months have passed. What are the new characteristics of the global inflation trend? How much more can oil prices drive inflation? What changes have occurred in core inflation?
I. The United States: Energy prices have dropped and core inflation has declined
The impact of oil prices on overall inflation in the United States is very significant. The weight of energy prices in the US CPI is second only to that of food, and their fluctuations are much higher than those of other items. Therefore, the changing trend of the US CPI is highly consistent with that of the energy sub-item. Since the second half of 2016, international oil prices have rebounded significantly, leading to a year-on-year increase in energy CPI, which was the main driver of the previous rise in inflation in the United States.
Since March, inflation in the United States has continued to decline, but energy prices remain a significant factor. Since March, inflation in the United States has dropped rapidly. The year-on-year rate of PCE prices has fallen from a high of 2.2% in February to 1.7% in April, and the year-on-year rate of CPI has also dropped from 2.7% in February to 2.2%. This is mainly because the month-on-month growth of oil prices has been weak, while the base has gradually risen, and the pull of oil prices on the CPI has significantly weakened. Since February, oil prices have been fluctuating and weakening within the range of $48 to $55 per barrel. The year-on-year growth rate has dropped significantly from nearly 80% at the beginning of the year to 8% in May. As a result, the energy component in the CPI has decreased from 15.2% in February to 9.3% in April. As the oil price base continues to rise, it is expected that the overall CPI growth rate in the United States will continue to decline in the future.
However, oil prices cannot account for all the changes. After excluding the influences of energy and food, the growth rate of core inflation in the United States is also weakening. The year-on-year growth rate of core PCE in the United States dropped from 1.8% in February to 1.5% in April, reaching the lowest level in nearly two years. The core CPI in April also fell to 1.9%, the first time in the past one and a half years that it has been below 2.0%. Both service and commodity prices have been weakening over the past 17 years. Particularly, the non-energy service sub-item, which accounts for 60% of the CPI (34% for housing), saw its year-on-year price growth rate drop sharply from 3.1% in February to 2.7% in April.
Specifically, among the commodity categories, education and communication, leisure goods, and household items are the main drag, while the price increase of medical and health products has narrowed. Among the service categories, the rent price, which accounts for the largest proportion, has remained stable for 17 years. The growth rate of medical and health service prices has continued to decline, and communication prices also dropped significantly year-on-year in March and April. These are the main reasons dragging down the service sub-items of the core CPI.
The weakening of inflation reflects the slowdown in the growth of consumption and income in the United States this year, essentially due to the relatively weak economic recovery. Inflation measures changes in consumer prices, and consumption largely depends on residents’ income. Since 2015, the year-on-year growth rate of hourly earnings of non-farm employees in the United States has risen from around 2% to 2.8%, showing an overall improving trend. However, in May 2017, the growth rate of hourly earnings of non-farm employees dropped to 2.5%, reaching the lowest level in nearly a year. If inflation is taken into account, the growth rate of real income for American workers has been continuously declining since the end of last year. The slowdown in income growth reflects the weak recovery of the US economy. The final GDP growth rate in the first quarter was only 1.2%, lower than the levels of the previous three quarters. Moreover, consumer demand dropped significantly in the first quarter, contributing only 0.4% to GDP.
As the interest rate level in the United States remains at a historically low level, a slow rate hike will have a relatively limited impact on the economy. Therefore, the Federal Reserve may still raise interest rates twice this year. Given that the Federal Reserve is set to change its leadership in 2018, it is also possible that it will start reducing its balance sheet within the year to promote the normalization of monetary policy.
Second, the Eurozone: Oil prices are also dominant, and economic recovery is gradually stabilizing
Oil prices are also the most important factor influencing inflation in the Eurozone. Since 2016, inflation in the Eurozone has rebounded rapidly. In February 2017, the HICP year-on-year growth rate once reached 2.0%. The significant increase in energy prices is also an important reason. In the first four months of this year, energy’s contribution to inflation in the eurozone remained between 0.7% and 0.9%, contributing the main part of the inflation recovery. Therefore, the eurozone is also facing the risk of overall inflation falling due to the year-on-year decline in oil prices in the future.
However, compared with the United States, core inflation in the Eurozone is more stable after excluding the factor of oil prices. In April, the core HICP of the eurozone rose by 1.2% year-on-year, reaching the highest level in 13 years. Although it dropped to 0.9% in early May, it was still higher than the growth rate in the second half of last year. Compared with the United States, the performance of core inflation in the Eurozone was better. From the perspective of specific sub-items, prices for rent, health care, and vehicle purchases have all remained stable with a slight increase. The prices of entertainment and culture as well as restaurants and hotels rose significantly year-on-year in April, which were the main sources supporting the rise in core inflation.
This indicates that under the stimulus of loose monetary policy, the economic recovery of the eurozone in the first quarter was more stable compared with that of the United States. The eurozone’s GDP rose by 1.9% year-on-year in the first quarter, further improving compared with the growth rate in 2016. The seasonally adjusted GDP was 0.6% quarter-on-quarter, the fastest growth rate since the second half of 2015. Behind its recovery, the main factor is the continuous stimulus of loose monetary policy. Over the past 14 years, the credit growth rate of the eurozone’s banking sector has continuously improved from -2% to around 4%. However, after 11 years of raising interest rates too early and then cutting them again, the European Central Bank’s attitude towards exiting the easing policy this time is clearly more cautious. The European Central Bank’s meeting in June kept interest rates unchanged. Although it removed the wording that there might be another rate cut, it also lowered inflation expectations considering the impact of energy prices. Quantitative easing will continue until inflation continues to rise.
Iii. Japan: The overall level remains low, and the core improvement is slow
Japan’s overall inflation has slumped again in 2015. After rebounding last year, it has remained at around 0.3%, but core inflation has been improving since the beginning of this year. In April, Japan’s national CPI rose by 0.4% year-on-year, remaining at the average level of the past six months and relatively low among major economies. However, it is worth noting that Japan’s core inflation has been continuously improving recently. After turning positive in 2017, it rose to 0.3% year-on-year in April. From the perspective of specific sub-items, the public utility sub-item including fuel remains the biggest factor influencing the rebound in inflation. Among the sub-items other than food and energy, the year-on-year growth rates of clothing and transportation and communication prices have successively increased significantly.
This indicates that Japan’s economy has also been recovering slowly since the beginning of this year. The year-on-year growth rate of private consumption in Japan has risen from a negative value last year to 0.9% in the first quarter, showing an overall moderate recovery. Production also maintained an expanding trend. The PMI for manufacturing and services continued to rise, reaching 53.1 and 53.0 respectively in May, both being relatively high levels in recent years, reflecting a slow improvement in the economy. As Japan’s inflation level remains low and its economic recovery is slow, the Bank of Japan’s loose monetary policy will continue.
Fourth, domestically: Inflation expectations have declined, and structural differentiation has emerged
Food prices continue to fall, while services tend to rise
Although the overall domestic CPI has risen slowly, it remains at a low level mainly due to the drag of food prices. Since February, the year-on-year growth rate of domestic CPI has been slowly rising from a low of 0.8%, reaching 1.5% in May. However, compared with historical levels, it still remains in a relatively low range. The overall sluggishness of the CPI was mainly due to the drag of food prices. The year-on-year decline in food prices was above 4% in February and March, and gradually narrowed in the following two months. In May, the year-on-year decline was -1.6%, which was still considerable. However, the year-on-year core CPI rose slowly and remained stable at around 2.1%.
The trend of food prices is significantly weaker than the seasonal ones. Due to the influence of the warm winter, the month-on-month trend of food prices during this year’s Spring Festival was significantly weaker than in previous years, but the decline after the festival was very large, indicating that this year’s food prices are not only affected by seasonal factors. From a structural perspective, the price trends of fresh vegetables and fresh fruits basically follow seasonal fluctuations. However, since the third quarter of last year, the price of pork has dropped by 14% cumulatively, and the price of eggs has fallen by 31%, exceeding the seasonal fluctuations and exerting a significant drag on food prices.
The decline in pork prices is partly due to the increase in pork prices last year, which stimulated an increase in supply. Currently, the ratio of pork prices to grain prices remains at 7.63, higher than the level of previous years. On the other hand, while the increase in real estate prices boosts consumption in decoration, furniture and home appliances, it also has a certain crowding-out effect on other types of consumption. The price of eggs is mainly influenced by factors such as the decline in feed costs, increased supply and avian influenza.
The prices of non-food service items have risen significantly. Overall, non-food prices mainly show seasonal fluctuations. However, the increase in service prices was very significant, reaching 2.9% year-on-year in May. Among them, medical services rose by 5.8% year-on-year (mainly affected by medical reform policies), home services increased by 4.2% year-on-year, clothing processing services by 4.1%, rent by 2.9%, and education, culture and entertainment by 2.6%, reflecting the continuous upgrading of consumption. Among the commodity prices, the year-on-year increase in the prices of both Chinese and Western medicines exceeded 6%, mainly driven by upstream costs. The year-on-year growth rate of fuel for transportation vehicles was 10.2%, but as oil prices weakened month-on-month and the base rose, they are expected to decline in the future. Overall, the previous rebound in the PPI had a very limited impact on non-food prices in the CPI, mainly reflected in energy prices.
- The PPI is tending to decline, but the structure is showing signs of differentiation
Due to the month-on-month decline and the increase in the base, the year-on-year PPI dropped from a high level. Since the beginning of the year, the year-on-year growth rate of the Producer Price Index (PPI) has continuously dropped from a peak of 7.8% to 5.5% in May. Among them, the price of production materials has dropped from over 10% to the current 7.3%, which is the main factor driving the fluctuation of the PPI. Meanwhile, the price of consumer goods remains at a low of 0.6%, having declined in the past two months.
From the perspective of specific industries, the prices of the coal, steel and oil industries have all weakened. The coal industry was mainly affected by the relaxation of the “276 Policy”, with the intensity of capacity reduction weakening and supply increasing. The average available inventory days of coking coal in large and medium-sized domestic steel mills have rebounded to over 14 days, and the coal inventories of the six major power generation groups are also at relatively high levels. So the price of the coal mining and selection industry dropped by 0.6% month-on-month in March and declined again in May.
In the steel industry, the previous price hikes pushed up industry profits, leading to a recovery in production and an increase in inventory. Currently, the inventory of major steel varieties is still 12% higher than that of the same period last year. However, the demand in the automotive and real estate sectors is tending to decline. The prices of ferrous metal mining and selection dropped by 2.6% month-on-month in April and continued to decline by 4.1% in May. In the energy sector, the production cuts by OPEC have had limited effect. Meanwhile, the continuous exploitation and supply of shale oil in the United States have been suppressing international oil prices. Since the beginning of this year, the ex-factory prices of domestic gasoline and diesel have both dropped by 3%, and the prices of oil-related industries have also weakened significantly.
It is worth noting that in industries where the proportion of private capital is relatively high, there is market-based capacity reduction and prices remain relatively stable. In fields such as rubber and plastics, chemical fibers, chemical raw materials, papermaking and printing, the proportion of state-owned assets is less than 15%, far lower than over 50% in the steel and coal sectors.
The continuous sluggishness of the market has stimulated a certain degree of spontaneous capacity reduction in these industries. For instance, in the cement industry, apart from the nationwide staggered production and capacity reduction organized by local governments, the number of mergers and reorganizations among enterprises within the industry has increased. In the synthetic rubber industry, capacity reduction reached 130,000 tons in 2016. Since the second half of last year, the prices of these industries have been continuously rising. Under the current circumstances where the PPI has dropped, the price performance has remained relatively stable. However, looking ahead, the task of cutting overcapacity in industries such as cement, papermaking and chemical engineering remains arduous.