Inflation Warning

We, Mr China, issue our first inflation warning for China in this site.

On 3 Nov 2010, the US Federal Reserve decided to print an additional USD$600 billion dollars by mid 2011 against the possible risks of slow economic recovery, continued unemployment, and also domestic deflation.

Together with the US Federal Reserve's previous decision to re-invest principal from current holdings of agency debt as well as agency Mortgage-Backed Securities (MBS) since 10 August 2010 by restarting purchase of the longer-term government bonds that originally intended to avoid the upward pressure on longer-term interest rates which might result if those holdings were allowed to decline, this so-called QE2 (Second Round of Quantitative Easing) package will print up to a total amount of USD$900 billion dollars and will eventually increase the inflation pressure to a warning level here in China.

According to the US Federal Reserve, since the decision on 10 August 2010 to begin re-investing principal from such current holdings, asset purchases were concentrated on US government bonds with maturities of 2 to 10 years, though some shorter-term or longer-term securities were also purchased along with some Treasury inflation-protected securities (TIPS).

While asset purchases would continue to be concentrated on US government bonds with remaining maturities between 2 and 10 years, newly purchased government bonds would be expected to have a duration of 5 to 6 years on average. The additional USD$600 billion asset purchase of longer-term government bonds by the end of the second quarter of 2011 would be processed at a pace of around USD$75 billion per month in order to avoid disruptions in normal market functioning.

In fact, Ben Bernanke, Chairman of the US Federal Reserve, already gave hopes for additional rescue to the market earlier on 21 July 2010 by starting to describe US economic outlook as "unusually uncertain".

Since then, the market already expected that there would be some kinds of easing policy to be released by the Fed, and just not sure about the amount of money it would involve. Now the QE2 policy has come out, and it seems there are even more questions remain unanswered.

The main uncertainties are, of course, that whether the QE2 can really boost the US economic recovery, improve the employment market situation and also get rid of the possible deflation. In a broader view outside the US, people are also wondering how serious the QE2 will impact the rest of the world, especially for the emerging markets that have inflationary pressure already reached or going to reach their warning levels.

We believe, however, the key of success for QE2 is whether US can find ways to effectively keep hot money inside its own country.

Japan is a good real example - money kept flowing out through carry trade and therefore failed to create domestic inflation expectation.

We trust that, unavoidably, hot money will continue to flow into emerging markets including China.

Our existing China CPI target of +3.5% in 2011 basically assumed that the Chinese Central Bank would quickly react to the impact of this QE2. If the action of the Chinese Central Bank is not quick enough, certainly we will have to lift up our 2011 CPI target.

That is why we have to issue this urgent inflation warning.


Related article(s):
2011 CPI target
2011 GDP target
Setting our own targets