China’s effort to boost manufacturing and shore up the economy amid a real estate slump could put “meaningful upward pressure” on US inflation and push back the start of monetary easing, according to new research by the Federal Reserve Bank of New York. 

Credit flows to China’s factories have accelerated sharply over the past few years, as authorities seek to compensate for diminished lending to the property sector. That’s matched by a shift in rhetoric from Chinese leaders as they talk up industrial policy. The new approach stands a chance of boosting China’s economic growth above the rates of the past two years, at least in the short term, New York Fed economists wrote in a blog post this week. 

If that scenario plays out, the extra demand from Chinese manufacturers would likely push up prices for commodities and intermediate goods, and result in a weaker dollar, according to the New York Fed team. That would “persistently tilt the balance of risks for US inflation to the upside,” the economists wrote. “Such an impetus to inflation could potentially delay market expectations for policy easing.”

The Fed’s preferred gauge of US inflation eased to 2.4 per cent in January – less than half what it was a year earlier, but still above the 2 per cent target. Investors currently expect the central bank, which hiked rates at the steepest pace in decades to combat pandemic inflation, to start cutting them in June or July.

The New York Fed team said its finding “is at odds with the apparent conventional wisdom, which holds that a manufacturing-led expansion in China would be disinflationary for the US.” While the prices for Chinese manufactured goods would likely fall because there’d be more of them, that would be outweighed by the other effects such as higher commodity costs, they wrote. 

Any boost to Chinese economic output achieved by the switch in credit flows would likely be a short-lived “sugar high,” since China already has an “outsized presence in the global manufacturing ecosystem,” the New York Fed argued. BLOOMBERG

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