Can the Middle East conflict accelerate the re-inflation process?

Recently, domestic price level data has brought an unexpected positive surprise to the market. According to the National Bureau of Statistics, due to the offset of the Spring Festival and record-breaking consumer spending, China’s February CPI year-on-year rebounded sharply to 1.3%, far exceeding market expectations of 0.9%, with core CPI rising to a phased high of 1.8%. PPI year-on-year decline narrowed continuously to -0.9% (expected -1.1%), and both consumer and producer sides experienced unexpected re-inflation. As tensions in the Middle East persist, markets are beginning to price in a long-term blockade of the Strait of Hormuz, with Brent crude oil prices surpassing $100 per barrel. External energy shocks may accelerate China’s re-inflation process.

This external shock, combined with the previously evident rising trends in metals and some raw materials, adds significant uncertainty to China’s already recovering inflation outlook. In the foreseeable future, mechanical re-inflation driven by global energy shocks is replacing endogenous demand, becoming the main force pushing up domestic prices.

However, for China’s economy, which faces long-term downward price pressure and is still in the recovery stage of domestic demand, this imported inflation is more like a double-edged sword: on one hand, it helps to curb the relatively stubborn deflation expectations of the past three years; on the other hand, if downstream demand lacks elasticity, cost-push inflation will squeeze profits of mid- and downstream enterprises, thereby dragging down employment and failing to generate positive spillover effects on corporate profits and residents’ income.

Mechanical re-inflation appears, but profit margins face a major test

While imported inflation helps to break deflation expectations, if terminal demand remains weak, rising upstream costs will be difficult to smoothly pass through to end consumers; it will also intensify profit differentiation across industries and may not necessarily correspond to demand-driven healthy re-inflation.