The Relationship between Commodity and Consumer Prices in Mainland China and Hong Kong

It is often argued that changes in commodity prices can provide a timely signal of future movements in CPI inflation because they are a sensitive leading indicator of global demand conditions. The sharp increase in commodity prices since mid-2003 has raised concerns about whether this is a precursor to higher consumer price inflation in regional economies. Our empirical results suggest that changes in non-fuel commodity prices have significant predictive power for headline CPI inflation for Mainland China and Hong Kong, while changes in energy prices are not significant. The results are the opposite for the US. For Hong Kong, a 1% increase in non-fuel commodity prices is associated with an increase of 0.5 percentage points in headline CPI inflation after two years. This may reflect a correlation between Hong Kong housing prices (and the rental component of the CPI) and global growth. If rents are excluded, the estimate falls by one-fifth, to 0.4 percentage points. For Mainland China, the relationship between changes in commodity and consumer prices is unstable over the past two decades, reflecting structural changes in the economy and the difficulty in controlling for changes in monetary conditions over the period. Shortening the sample period to post-1997, a 1% rise in non-fuel commodity prices is associated with a 0.4 to 0.5 percentage-point-increase in future CPI inflation. These estimates are larger relatively to those found in other studies on developed economies, which could be due to several factors, including openness, a relatively large share of food prices in the CPI, and, for the Mainland, the size and commodity intensity of its manufacturing sector.