Chinese factories are again threatening to drag down prices around the world as the cost of their goods decline by the most since 2016.
In a fresh challenge to the ability of global central banks to revive inflation, China’s slowest growth in almost three decades and cheaper energy costs have left manufacturing prices declining since July.
While cheaper goods may be a boon to foreign consumers as Christmas nears, the overall effect is a potential spiral of falling prices worldwide as companies everywhere are forced to compete with Chinese rivals to protect profits.
That would add further tension to the US-China trade dispute.
“Inflation is increasingly driven by global factors, and in particular, by waves of disinflation emanating from China,” Stephen Jen and Joana Freire at Eurizon SLJ Capital Ltd said. “This is related to China exporting its overhang of capacity” which has been exposed by weak domestic demand, trade tensions with the US, and lack of economic stimulus.
They expect the recent worsening of the producer price index (PPI) to weigh on inflation rates in the US and Europe, similar to what happened from 2014 to 2016.
Producer prices in Germany, Japan, South Korea and the US are already negative.
Data released on Saturday underscored the problem, with Chinese producer prices last month dropping for a fourth month.
Input costs and energy prices have fallen since June, reducing costs for producers. However, those savings have not boost companies’ margins as demand is not strong and there is plenty of excess capacity, so manufacturers have also cut asking prices.
“The US-China trade war is paralyzing global capex spending and delivering a massive deflationary shock,” said Chua Hak Bin (蔡學敏) at Maybank Kim Eng Research Pte in Singapore.
US tariffs are diverting China’s excess capacity and supply to third countries, and more companies and nations are likely to feel the deflationary pressures, Chua said.
The deflation risk reflects China’s heftier role in the world economy and how for many industries it is a price setter.
It made up 12 percent of total global trade last year, the largest single country.
Chinese price shocks accounted for about 6 percent of average inflation globally, according to a 2016 analysis by Bundesbank economists.
Similar to what happened in 2014 to 2016, a flow of cheaper goods from China will make it harder for central banks elsewhere to generate sustained inflation.
Consumer prices in Japan, Germany and the US are already below their inflation targets of about 2 percent a year, and further declines in the price of imports and manufactures will only make it harder to reach those goals.
China is the biggest source of imports for the US and Japan, and the second-biggest for Germany, after the Netherlands.
In addition to falling PPI, discounts by Chinese companies to compensate for tariffs might be having an effect on the price of goods sent to the US, and some of the decline in export prices is likely due to the yuan weakening against the US dollar, making Chinese goods cheaper for companies in many countries.
Still, China’s producer deflation is nowhere near as bad as the low of minus-5.9 percent seen in 2015, and much of the current drop is due to cheaper energy and commodity prices, Michael Shaoul of Marketfield Asset Management said.
If energy prices stay stable, China’s factory prices may become neutral, he said.
Economists expect producer prices to bottom out in the fourth quarter before recovering slightly.
As for consumer prices in China, the overall measure is actually rising as soaring pork prices push up foods costs.
That is caused global bacon prices to increase and is pushing up the cost of other meats.
“China’s PPI deflation is a result of both weak commodity prices and weak domestic demand,” said Lo Chi (羅念慈), greater China economist at BNP Paribas Asset Management in Hong Kong.
“The China factor is disinflationary at this point but not deflationary,” Lo added.
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