MNI SURVEY: Despite China Mkt Worry, Analysts See Mild '18 CPI

     BEIJING (MNI) - Despite growing concerns among Chinese bond investors about

the domestic inflation outlook, China analysts generally expect price pressures

to remain relatively modest next year.

     The yield on 10-year China government bonds (CGBs) rose rapidly in October,

in part due to growing worries about the Chinese price outlook following the

19th Communist Party Congress last month. At the Congress, President Xi Jinping

underscored the government's commitment to reduce excess industrial capacity and

rein in pollution, both of which would tend to reduce supply and so increase

prices. 

     However, analysts with 10 Chinese financial firms generally agreed that

prices would remain under control in 2018. Nine of the ten predicted headline

CPI would not exceed 2.5%, with two even expecting CPI to be lower than 2%. The

one analyst who expected 2018 CPI to be higher than 2.5% said it would not

exceed 3.0%. 

     Chinese CPI rose 1.6% year-on-year in September, down from 1.8% in August.

October CPI data is due to be released on Thursday. 

     One key factor worrying bond investors is the recent rise in oil prices.

The price of WTI crude has risen nearly $15 per barrel since August, reaching

$56.97 per barrel on Wednesday. 

     "If OPEC reaches agreement to cut their production again, the oil price

could move up to $60 per barrel. However, the supply of shale oil will also go

up as oil prices go up, so that will partly offset the impact of OPEC production

cuts, so we don't expect the oil price will go up a lot," Xu Hanfei and Liu Yu,

analysts at China Merchant Securities, said in a report published last weekend.

"And a $10 rise of the oil price would not have a significant impact on the

consumer price index."

     In addition to the direct impact on the CPI, a rise in oil prices would

theoretically lead to a higher producer price index (PPI), boosting consumer

prices via higher production costs. However, this transmission mechanism breaks

down in China. 

     "From January 2016 to now, the Brent crude price has risen 82.6%, OPI

mining prices are up 31.8%, PPI raw material prices have risen 16.0%, while the

processing industry price index only rose 9.2%. You can see that the impact of

the rising crude oil price has been absorbed during the transmission process,"

Han Ping and Qi Sheng, analysts at Zhongtai Securities, argued in a report

published over the weekend. "The transmission mechanism from PPI to CPI is

blocked even more. From 2014 to 2015, the PPI fell 11.6%, while the CPI fell

only 0.6%. During 2016 and 2017, the PPI rose 11.4%, while the CPI rose only

0.8%. The CPI has generally remained stable."

     "The price of raw materials rose due to the impact of supply-side demand

and the campaign to cut excess capacity, while the demand side remained

generally stable, making it very difficult for higher PPI to lead to higher

CPI," Han and Qi argued. "Unless demand grows significantly, CPI will not face

major upward pressures."

     Ming Ming, an analyst at CITIC Securities, estimated that the influence of

higher oil prices might cause the CPI to rise to 2.5%-3.0% in 2018.

     But other analysts argued that PPI growth could decelerate sharply in 2018,

holding down CPI. 

     "We estimate the price of steel will likely decline gradually and the price

of crude oil will also fall to around $53 per barrel due to more supply from

shale oil," Meng Xiangjuan and Qin Tai, analysts at Shenwan Hongyuan Securities,

said last week. "Given that the campaign to cut excess capacity has almost

finished and the price of steel will go down slightly, we think the price of

coal might go down slightly as well."

     "So throughout 2018, average PPI might fall below 1.0%," Meng and Qin

predicted, compared with an average of 6.5% in the first nine months of this

year.

     Price increases for medical care, a key factor pushing up CPI this year,

will likely decelerate next year. 

     In September, consumer prices for medical care increased to 7.6% y/y from

5.9% in August, meaning headline September CPI would have been below 1.0% if the

medical price component had been taken out, CICC estimated. Medical service

prices jumped 9.2% y/y in September, up from 6.4% in August.

     So far this year, medical care prices are up 5.2% y/y, much higher than the

average increase of 3.8% in 2016.

     "The rising price of medical care has to do with medical care reform,"

China International Capital Corp. (CICC) said in a report last weekend. "Medical

care prices will not maintain such rapid increases, and the cycle of rising

prices will end because medical care reform has been nearly fully implemented." 

     A new round of medical care reform started in 2017, aiming to increase

charges for medical services while bringing down the price of medications.

     Another worry for bond investors comes from the potential rise in food

prices in 2018. Food prices make up about one-third of the weighting in the

consumer price index. 

     Non-food CPI has been relatively high so far this year, remaining above 2%

from January to September. However, food CPI growth has been negative since

February this year, dragging down headline CPI growth.

     "Grain prices have been the main factor lowering food prices and the price

levels have been relatively low. According to our estimates, grain is the second

most powerful factor affecting overall CPI, only weaker than oil prices," CICC

said. "Since the fourth quarter last year, grain prices have increased

continuously ... so it is natural for investors to worry about inflation next

year."

     "However, grain prices will not put huge pressure on inflation next year.

Corn might add some price pressures later this year and early next year [due to

a slight contraction of supply and higher demand from feed and industries],

while wheat and rice will have a negligible impact on food CPI next year [as

both have high inventories]," CICC said. "Pork and vegetable prices might rise

more sharply than grain prices, leading to higher, but not too high, CPI

growth."

     Other analysts predicted the price of pork, a major swing factor in

consumer prices in recent years, might also decline.

     "Historically, every round of inflation has been pushed up by rising food

prices," said Dong Dezhi and Li Zhineng, analysts at Guosen Securities,

estimating that inflation could very possibly come in below 2% next year. "Food

prices are determined by the inflation expectations of farmers."

     According to Dong and Li's estimates, the life cycle for pigs -- from birth

to slaughter -- will be 192.4 days in 2017, lower than the 200.1 in 2016 and

much lower than the peak of 255.7 in 2011. The life cycle of pigs is an

indicator of farmers' inflation expectations, with farmers increasing their

inventories and the life cycles of their pigs if they expect inflation to rise. 

     "As economic growth is unlikely to go up significantly next year, farmers'

disinflationary expectations might continue and the life cycle rate for

agricultural products will be faster and thus increase food supply and alleviate

inflation pressures," Dong and Li wrote. 

Companies                  2018 CPI Predictions

-----------------------------------------------

CICC Macro                                 2.5%

CICC Fixed Income             Slightly Above 2%

Orient Securities                          2.2%

China Merchant Securities                  2.2%

Hua Chuang Securities                      2.5%

Guotai Junan Securities                    2.5%

Tianfeng Securities                    Under 2%

Guosen Securities                      Under 2%

Zhongtai Securities                 2.2% - 2.3%

CITIC Securities                    2.5% - 3.0%

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

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

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

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