China: Inflation and monetary policy outlook


The recent surge in factory-gate prices adds to inflation worries, but there’s little evidence of demand-driven pressures.
Nathan Chow27 May 2021
  • Unlike previous cycle, PBOC is not expected to tighten drastically soon
  • Bond defaults will rise further if government support wanes amid increasing redemptions
  • Implications to our forecast: we expect the LPRs to stay steady in the coming months
  • Implications for investors: We are still comfortable with CGB duration
Photo credit: AFP Photo


Moving into the early stage of a new cycle typically means tightening policies and steeper curves. To illustrate, PBOC raised the one-year MLF rate consecutively during 2017-2018 to counter inflation resulting from the country's multitrillion Public-Private Partnership projects. Back then, the ramp-up in the PPP pipeline has fed an infrastructure investment boom. Producer prices soared 6.9% YOY in January 2017, the month before PBOC began to hike.

The recent surge in factory-gate prices also adds to inflation worries. Yet, unlike previous cycle, the authority is not expected to tighten drastically anytime soon. Not least because the pickup in producer prices has in large extent been propelled by global supply bottlenecks. The pass-through effect is limited hitherto. Despite April’s headline PPI jumped 6.8%, producer prices of consumer goods edged up a mere 0.3% (see here).

Barring the resurgence of COVID-19, the recovery in household consumption should spur gains in service prices later this year, particularly for catering, travel, and entertainment. But the process will be gradual and moderate, as evidenced by the still low core CPI reading and the subdued durable goods prices. Falling food prices may also help keep inflation at bay as pork production continues to recover.

Mirroring this is the unbalanced recovery. Both industrial output and investment buoyed by strong exports and a hot property market in April. However, retail sales growth softened to 4.3% on an average two-year basis from 6.3% in March. The setback suggests consumer demand is yet ready to replace investment as a driver of growth.

An over-tightening would jeopardize the growth recovery. Efforts to restrain debt growth has already led to a significant slowdown in credit impulse. April’s total social financing growth weakened the second consecutive month to 11.7%, as shadow financing contracted, and corporate bond financing as well as bank loans slowed. M2 slumped to 8.1% from as high as 11.1% in mid-2020. Note that the authority’s goal is to keep credit expansion roughly in line with nominal GDP growth, which we forecast will be in the 12%+ terrain this year.

A sharp turn in policy would also send a shock to the financial markets, which are currently pricing in a relatively benign scenario. The 10-year sovereign yield has fallen to the lowest level in eight months. Debt repayment is another concern. About USD1.3tn (RMB8.4tn) of domestic debt payable by May 2022, compared with USD1.0tn and USD0.8tn in the US and Europe respectively.

Challenges are particularly acute for state-linked firms, with RMB1.38tn of onshore bonds coming due in 3Q. That’s the fourth-straight quarter the figure will be larger than RMB1.3tn. A string of defaults by SOEs since late-2020 raised concerns about government backstop for such firms, amplified recently by worries surrounding China Huarong Asset Management Co. That put the onus on PBOC to ensure sufficient liquidity buffers, especially as banks’ excess reserve ratio has remained low for several months.

We expect the LPRs to stay steady in the coming months. Should inflation pressures gather further momentum, regulators could roll out targeted measures to tackle the rising raw material prices. The China Iron and Steel Association is already working with the Dalian Commodity Exchange to reform the delivery system to reduce market speculation. Other potential policies include a further tightening of credit growth from specific sectors and releasing certain metals stocks by the State Reserve Bureau.

On the rates front, shorter-term rates are not showing any signs of upward pressures, leading to increasing demand for duration. We have been comfortable with CGB duration since 4Q last year and recently reiterated our stance (see here). We have re-centered our 2Y and 10Y CGB yield forecast to 2.75% and 3.30% respectively. We think CGB will be one of the more resilient govvies in Asia even as Fed taper risks loom in 2H21. While price gains are likely to be more muted from here on, we think that the yield and stability offered by CGB is compelling. We still have a running long 30Y CGB idea (see here).


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
[email protected]


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

The information herein is published by DBS Bank Ltd (the “Company”). 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 intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. 

DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-878-9999. Company Registration No. 196800306E. 

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


The information set out in this website ("Information") 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. This 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 Information is published for general circulation only and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person. Visitors accessing this website should always seek advice from an independent financial adviser regarding the suitability of the Information referred to herein (taking into account the specific investment objectives, financial situation and/or particular needs of each person in receipt of the Information) before making any investment and/or any purchase in reliance of the Information. Please refer to the actual research publications for important disclaimers and disclosures, where applicable.