China reopens, and the world gets a new inflation problem

Markets have decided that China's eventual exit from zero-Covid will be pure good news for global inflation. Industry may prove them wrong. Investors are cheering the prospect of clearer factory bottlenecks and emptier ports, but they have largely ignored the demand shock that comes with it. A $17-trillion economy that gets moving again will ship cheaper manufactured goods, and it will also buy up the marginal barrels of energy, tonnes of industrial metals and cargoes of food.

The People's Bank of China signalled the change on 25 November by cutting the reserve requirement ratio by 25 basis points, putting more liquidity into a credit system keen to finance a recovery. The trade-off is plain enough. Falling prices for traded consumer electronics will be offset, and sharply, by rising commodity prices further up global supply chains.

Beijing has already started

The easing has been building for weeks. On 11 November the National Health Commission published 20 measures that shortened quarantines and dropped the rule suspending international flights that carried infected passengers. Regulators followed with a package telling banks to extend developers' maturing loans and keep credit flowing to the property sector. The protests that spread across several cities over the weekend, after a deadly fire in Urumqi, add political pressure to an economic case Beijing had already begun to make.

None of this amounts to a reopening date, and the path will be halting. Officials still describe their approach as dynamic zero-Covid even as they loosen its rules, and this year's growth target of around 5.5 per cent has slipped far out of reach. Commodity markets do not wait for the finished article, though. They price the marginal buyer, and the marginal buyer for most raw materials is Chinese.

China wants its oil back

During the lockdowns of 2022, weak Chinese demand freed up cargoes of liquefied natural gas and held down crude consumption, which helped Europe get through its terms-of-trade crisis. Chinese importers resold gas cargoes they no longer needed, and many of those ships sailed for European terminals. A revived Chinese aviation and logistics sector would take that slack back quickly. If Chinese oil demand rose by even a modest one million barrels a day, the spare capacity held by OPEC+ would be gone, and a shaky truce in energy markets would turn into a bidding war.

Supply is tightening at the same moment. OPEC+ agreed in October to cut its production target by two million barrels a day, and the group meets again on 4 December. The European Union's embargo on seaborne Russian crude starts the following day, alongside a G7 price cap whose level is still being argued over in Brussels. Any Chinese demand that returns will be bidding for barrels in a market already short of goodwill.

Copper, iron ore and industrial chemicals follow building activity and property completions more closely than headline GDP. Metals weakened through the spring and summer as lockdowns in Shanghai and elsewhere idled factories and building sites, though a strong dollar and Fed tightening played their part. Even a half-finished rescue of the property sector needs a lot of physical material, and that puts a floor under global raw material prices just as Western central banks are trying to destroy demand.

What 2009 suggests

The nearest precedent is the stimulus Beijing announced in November 2008, a four-trillion-yuan spending programme aimed largely at infrastructure and construction. Western economies spent the first half of 2009 in recession, yet copper more than doubled over the year as Chinese buyers restocked. Metals prices recovered long before Western final demand did, and imported commodity costs fed through to Western producer prices soon afterwards.

The comparison flatters the bulls in one respect. Beijing is not promising a credit binge of that scale, and the property sector it is now propping up is shrinking. The direction of the shock is the same, however, even if its size is smaller.

Rate rises stop at the border

That leaves the Federal Reserve and the European Central Bank in an awkward spot. Higher rates are meant to curb interest-sensitive spending at home. They do nothing to curb Guangdong's appetite for copper or crude.

The Fed has raised rates by 75 basis points at each of its past four meetings, taking its target range to 3.75-4 per cent, and the ECB lifted its deposit rate to 1.5 per cent in October. Both meet again in mid-December, and both expect headline inflation to fall next year with help from cheaper energy and cheaper goods. A commodity rebound removes one of those two supports.

The timing is awkward for a second reason. American consumer prices were still rising at 7.7 per cent a year in October, down from 9.1 per cent in June, and much of that improvement came from lower petrol prices. Energy has done the heavy lifting on the way down, so a renewed rise in crude would reverse the part of disinflation that central bankers have found easiest to bank.

Who pays for Chinese demand

The winners from a reopening are easy to list. Commodity exporters such as Australia, Brazil and Chile would gain on their terms of trade, and their currencies tend to rise with metals prices. Asian tourism and luxury-goods companies, which have lost Chinese travellers for nearly three years, would regain their best customers.

The losers are the big energy importers. Europe has filled its gas storage for this winter, but refilling it for next winter without Russian pipeline gas means competing for LNG cargoes with Chinese buyers who have been absent for most of this year. Japan, South Korea and India, all heavily reliant on imported fuel, would face higher import bills just as their currencies are weak against the dollar. For them, a Chinese recovery arrives as a tax.

The case for calm

The strongest objection is that reopening may start with a surge of infections that keeps Chinese workers and shoppers at home for months, as Hong Kong's Omicron wave did earlier this year. Western demand is also weakening, which frees up barrels and cargoes elsewhere. Both points argue about timing more than direction.

The indicators to watch are China's official purchasing managers' indices at the end of each month, its monthly crude imports and property sales, and whether OPEC+ answers stronger demand with more supply or with silence. A rise in Chinese domestic flight numbers would be the earliest sign that fuel demand is coming back.

If commodity prices rebound just as goods prices stop falling, headline inflation will prove maddeningly sticky. Beijing's reopening will probably push up inflation in the West through oil and metals prices in the coming months, well before it does anything to fix supply chains, and Western central banks will have to hold rates higher for longer to cope.