How to read inflation in Chinese

China's GDP was always meant to fall back to more sustainable levels but its rising inflation, coupled with a US growth spurt, spells good news for Australia.

China’s inflation rate is picking up and this should be viewed as good news for Australia.

Higher Chinese inflation implies a number of things – either the economy is growing at a solid pace and price pressures are building, or there are rising prices in the cost of doing business. Which of these explanations carries the most weight at the moment in China will be sorted out when more information becomes available, but it is safe to say that stronger growth and rising domestic prices are good news for a commodity exporter like Australia.

The Chinese CPI showed inflation lifting to an annual rate of 2.7 per cent in June. This is up from 2 per cent at the start of 2013 and is the second highest reading in the last 12 months. While the annual inflation lift was centred on higher food prices, the disinflation that has been seen in China in 2012 has been replaced by a gentle broadly based acceleration in inflation.

The inflation data has seen the consensus view further scale back expectations of any further easing in policy, even though GDP in China is forecast to slow to a 23-year low of 7.5 per cent in 2013.

Amid all this, it needs to be remembered that China is restructuring towards a ‘new normal’. Gone are the days where GDP growth of 10 per cent and more was the norm. Those double-digit growth rates were doable when the economy was one-fifth the size it is now and incomes were rising from what were subsistence levels. But with economy now in the middle phase of industrialisation, GDP growth nearer 7 per cent is more likely than not to be what is achievable and sustainable for years to come.

Indeed, in 2011 the Chinese government announced a target for 7 per cent growth on average in its five-year plan for 2011-2015, a point that many economists and China economy watchers tend to ignore as they see growth rates cooling towards that pace. It was meant to be.

At the time of the new five-year plan, the government said, "We must maintain a proper level of economic growth in order to provide necessary conditions for creating jobs and improving people's wellbeing and to create a stable environment for changing the growth model and restructure the economy. We must ensure that economic growth is in accord with the potential economic growth rate".

In other words, there was a realisation that the potential rate of economic growth would inevitably be reduced as the economy matured. There were signs of overheating recently with property prices rising at bubble like rates and a construction boom that has seemingly left an uncomfortable glut of empty buildings around the country.

Importantly, 7 per cent GDP growth in China now when its annual output is around $US8.25 trillion contributes a lot more to global growth and demand for commodities and services than 20 years ago, where a 10 or even 12 per cent GDP growth rate occurred when annual output in China was around $US1 trillion.

In addition to the lift in Chinese inflation, there are some tentative signs of a lift in commodity prices. Admittedly, these higher prices are from a low base and it is clearly the case that the conflict in Egypt accounts for most of the rise in oil prices. That said, the broad based commodity price indices are up around 4 per cent in the last week.

Are these commodity prices a further sign of solid global growth and inflation risks? It is possible, but still too early to be sure.

Having an influence on commodity prices and the global inflation outlook is the steady improvement in the US economy. It now seems squarely on track to grow above 3 per cent next year, which would be the first time in seven years that such a growth rate has been achieved.

It needs to be remembered, given the hype about China, that the US is still the largest economy in the world, accounting for almost one-quarter of total global output and is almost double the size of China. The US growing at 3 per cent instead of 1.5 per cent is akin to China growing at 9 per cent versus 6.5 per cent.

It really does matter.

All of this suggests that a rise in Chinese inflation, a clear lift in the growth momentum of the US economy and just a hint that commodity prices are edging higher is the sort of good news that will help underscore a lift in optimism in Australia in the months ahead.

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