Inflation Accelerates In China Due Mainly To Rising Food Prices

Inflation in China accelerated in the last two months. The year to year increase in the consumer price index rose from 3.6% in September to 4.4% in October and 5.1% in November, well above the government's target of 3%. Comparable figures for the Producer Price Index are: 4.3%, 5.0% and 6.1% Inflation in consumer and producer prices are shown in the first chart, together with the prime lending rate, which is equal to the 1-year lending rate of the People's Bank of China.

Confronted with rising inflation, most governments tighten monetary policy by raising interest rates. Since 2007, China has raised its prime lending rate just once on October 19th from 5.32% to 5.56%, but it has raised the reserve requirement ratio six times. The last rise on December 10 brought the ratio up to 18.5% for large financial institutions and 16.5% for medium and small institutions.

So far the monetary tightening has had little effect in dampening activity or prices. Part of the reason that the increases in the interest rate and in the reserve requirement ratio have had such little effect on inflation is due to the fact that much of the inflation is the result of rising food prices that are not particularly affected by interest rates or reserve requirement ratios. The second chart compares the year to year changes in the food component of the Consumer Price Index with the changes in the non food component. As can be seen in this chart it is food inflation that accounts for the spikes in the overall rate of inflation.

The government has announced certain measures designed to deal with the food inflation directly. It has promised to increase the land used for food production as well to increase subsidies for agriculture output and the prices the government pays for food products.