China's Pollution Clean-Up To Boost U.S. Inflation: Brokerage

--U.S. Inflation Impact to Be Felt Just Before December FOMC

     BEIJING (MNI) - China's latest environmental protection campaign, which

started in April, has shut down thousands of factories and by official measures

has made the air more breathable. The impact may reach beyond the border and

influence a critical interest rate decisions by the U.S. Federal Reserve.

     While the possibility of a rate hike by the Fed in December already exceeds

90%, as indicated by 30-Day Fed Funds Futures, U.S. continues to come in below

expectations, clouding the outlook for further Fed hikes.  But U.S. price

pressures could well pick up in the coming months, as China's stricter

environmental measures have boosted prices for a number global commodities and

downstream products, argued economics team led by Lu Zhengwei at the securities

arm of state-owned Industrial Bank of China. 

     Two major pollution-curbing policy decisions by China, one in November of

2015 and another in April this year, have led to gains in commodity prices, as

indicated by the widely followed CRB Commodities Index, the brokerage said. The

effects of the environmental campaign that started in April will take about

eight months to be reflected in the U.S. Personal Consumption Expenditures (PCE)

price index, the Fed's preferred inflation gauge, which Industrial Securities

said lagged the U.S. CPI by three months. 

     For instance, iron ore prices rose after China began to stamp out the

country's inefficient "hole-in-the-ground" smelters in April. The capacity of

such largely unregulated operators was estimated to total 100 million tons, or

more than a tenth of the country's total crude steel output. As many of these

low-cost producers relied on melting scrap metal, shuttering them caused steel

shortages and shifted demand to output from cleaner plants that use

higher-quality imported iron ore. Imports of foreign ore by China in the first

nine months were up 7% y/y.

     Coal and other base metals saw similar gains as the clean-up campaign and

President Xi Jinping's supply-side reforms curbed industries from aluminum

smelters to starch plants, ultimately leading to higher prices and profits for

producers. As China is by far the world's biggest commodity user, producers in

other countries also had to accept higher prices for their raw material imports.

     Furthermore, as China remains the world's biggest exporter, higher costs of

its finished and semi-finished goods will be passed onto importers, goods

finishers and eventually consumers, with variable time lags, Industrial

Securities said. 

     Combining the time lags in the production chain from upstream raw materials

to end-user consumers, members of the U.S. Federal Open Market Committee will

likely be presented with an uptick in inflation by the time they meet next

month, Industrial Securities argued.

     That impact may be felt beyond this year, as it is looking more likely that

goods manufactured by China and shipped to the rest of the world will bear

higher production costs.

     During the Chinese Communist Party's 19th Congress this month, Xi exhorted

the country's political elite to "win the war on defending a blue sky," leaving

little doubt that the move toward tougher environmental regulations will be

sustained for years to come. 

     In the first three quarters this year, environmental supervisors were

dispatched by the central government to 31 provincial regions around the country

to check on companies that failed environmental standards. As many as 1,200

companies around Beijing alone have been ordered to halt or restrict their

operations this year. Fines and detainments were publicized to show the

determination of authorities.

     Environmental Protection Minister Li Ganjie said during the CCP Congress

that the central government is in the process of codifying environmental audits

into permanent law, replacing the current ad-hoc administrative measures.  

     Given China's stronger-than-expected growth this year, Xi and his deputies

may have been increasingly convinced that his reform push won't lead to a

stalled economy. 

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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