In the first two months of 2026, China's cumulative Consumer Price Index (CPI) and Producer Price Index (PPI) increased by 0.8% and decreased by 1.2% year-on-year, respectively. The GDP deflator for the first quarter is expected to remain in negative territory. The Government Work Report in March explicitly called for efforts to "shift the general price level from negative to positive and achieve a reasonable and moderate recovery in consumer prices." Concurrently, escalating tensions in the Middle East and heightened conflict between the US and Iran have triggered significant volatility in international oil prices. While the surge in oil prices might superficially align with the policy objective of fostering a reasonable price recovery, the question arises: is this the kind of inflation needed?

The significance of macroeconomic targets lies not in the numbers themselves, but in the real conditions of microeconomic entities they represent. The GDP growth target of 4.5% to 5% is not about inflating output figures through inefficient investment or inventory accumulation. Instead, it aims for a scenario where businesses proactively expand investment and households are willing to increase consumption, thereby genuinely activating the economy's endogenous cycle. Similarly, an inflation target of around 2% is not merely about pushing up prices. It seeks to break the negative cycle of "low prices leading to postponed consumption and investment, resulting in economic weakness" through moderate inflation, making improved corporate profits and rising household income a sustainable norm. In essence, what is needed is not inflation itself, but the underlying logic of a normally functioning economy that inflation reflects. The core policy objective is to rebuild and maintain a complete incentive mechanism characterized by "profitable enterprises, employed citizens with income, and societal confidence in the future."

It is crucial to distinguish between different sources of inflation. Stagflation driven by supply shortages, hyperinflation fueled by excessive money supply, or structural bubbles where asset prices soar without real economic improvement are undesirable. The true expectation is a demand-pull, moderate price recovery. A revival in demand spurs production expansion, improved corporate profits lead to stable employment and income, and restored confidence among microeconomic entities further supports consumption and investment. Moderate price increases should be a natural manifestation of a re-energized, well-functioning economy. This is the true meaning of "shifting the general price level from negative to positive and achieving a reasonable and moderate recovery in consumer prices."

Part 1: How Do Rising Oil Prices Transmit to Domestic PPI and CPI? As the lifeblood of industry, rising international oil prices significantly impact domestic PPI and CPI through direct and indirect channels.

1. Transmission Mechanism to PPI The impact of oil price increases on PPI is the most direct and rapid, primarily through cost-push channels. First, it directly elevates domestic oil prices. With China's crude oil import dependency around 70% and domestic refined oil prices directly linked to international benchmarks, fluctuations in international oil prices quickly transmit to domestic prices. The significant weight of mining and raw material industries within the PPI basket means international oil price movements are reflected in PPI changes relatively quickly. Second, transmission occurs vertically through the industrial chain. As the starting point of the chemical industry chain, higher oil prices sequentially increase the costs of basic chemicals like ethylene and propylene, which then transmit to intermediates and final industrial goods such as plastics, synthetic rubber, synthetic fibers, fertilizers, and pesticides. The effect diminishes at each stage; the closer to final consumer goods, the smaller the impact of the oil price shock, but the broader the industry coverage. Third, energy substitution and linkage effects occur. Rising oil prices can also push up the prices of substitute energies like coal through substitution effects. As the cost of using oil as fuel increases, industrial enterprises tend to shift towards coal and natural gas, boosting demand and prices for these alternatives. This linkage effect extends the impact of oil price increases beyond the petrochemical sector to energy-intensive areas like power, heating, steel, and building materials, further amplifying the upward push on the overall PPI level. Fourth, transportation costs increase. Fuel is a core component of logistics costs. Higher oil prices systematically raise expenses for road transport, shipping, and other logistics services. Since nearly all industrial goods involve transportation, increased transport costs have a broad, pervasive effect, permeating various PPI sub-items.

2. Transmission Mechanism to CPI The transmission of oil price increases to CPI involves a longer and more complex chain compared to PPI. First, it directly increases refined oil and transportation-related prices. China's mechanism linking refined oil product prices to international crude oil means international price hikes are relatively directly reflected in higher retail prices for gasoline and diesel. Operating costs for service industries like taxis, ride-hailing, and express delivery are closely tied to fuel prices, potentially leading these sectors to adjust service charges. Additionally, tourism and airfares are sensitive to fuel costs. Second, businesses may pass on increased costs to final consumer goods. Price increases upstream in the PPI eventually partially transmit to the ex-factory prices of downstream consumer goods, reflected in the industrial consumer goods component of CPI via the retail sector. For example, faced with higher production costs for items like plastic products, textiles, apparel, and home appliances, companies might raise prices to pass on cost pressures. However, the efficiency of this channel depends on the competitive landscape and demand elasticity in downstream industries. Intense competition or high inventories can limit cost-pass-through ability, causing a blockage in PPI-to-CPI transmission. Third, indirect transmission to food prices occurs. Oil price increases elevate food prices through multiple channels: rising costs of fertilizers and pesticides increasing agricultural production costs; higher fuel costs for agricultural machinery operation; increased transportation costs for agricultural products; and rising energy and packaging material costs in food processing.

Part 2: Impact Assessment: PPI and CPI Trajectories Under Different Oil Price Scenarios The assessment focuses more on the direct impact of oil prices. For PPI, this primarily affects the oil and chemical industries on the cost side. For CPI, the main impacts are on transportation and utilities. Sectors like food, beverages, agricultural products, and substitute energies (coal) are also affected, but their indirect impacts are complex and difficult to estimate accurately.

1. A 10% year-on-year increase in oil prices may raise domestic PPI and CPI by approximately 0.4 and 0.1 percentage points, respectively. Within the PPI basket, five sectors are significantly affected by oil price hikes and have high weights, collectively accounting for 14.1%: petroleum extraction, petroleum processing, chemical raw materials, chemical fibers, and rubber/plastics. Regression analysis yields impact coefficients of ICE Brent crude price changes on the year-on-year PPI for these sectors as 0.68, 0.41, 0.20, 0.20, and 0.05 respectively, with model R-squared values all above 70%. Weighted aggregation suggests a 10% year-on-year increase in international oil prices raises the domestic PPI year-on-year growth rate by about 0.4 percentage points. The impact of international oil prices on CPI is concentrated in non-food items. A 10% oil price increase is estimated to raise CPI year-on-year by approximately 0.11 percentage points. This works through its effect on refined oil prices, impacting the "Transportation and Communication" component (specifically "Energy for Vehicles"), and the "Residence" component ("Water, Electricity, and Fuel"). However, as the weights of these sub-items are no longer published, the relationship is observed via the link between oil prices and the non-food CPI. A 10% year-on-year increase in ICE Brent prices raises the non-food CPI by about 0.13 percentage points. Considering the non-food CPI's weight is around 86%, the total impact on headline CPI is roughly 0.1 percentage points.

2. Scenario Assumptions: Five Possible Oil Price Paths The Middle East situation and oil price trajectory are highly uncertain. Both the US and Iran face multiple challenges. The US must balance inflation control with maintaining influence in the Middle East, while Iran must choose between short-term security interests and long-term development space. Based on the severity of Strait of Hormuz disruptions and potential spillovers to neighboring oil producers, five scenarios are outlined, from low to high conflict intensity. Scenario 1: Conflict de-escalates rapidly within about two weeks, US-Iran diplomatic talks commence, Strait of Hormuz remains open. Core assumption: Brent falls to $65/barrel by end-March and stays there through year-end. Scenario 2: Internal conflicts in Iran intensify within a month, involving Kurdish and Baloch opposition groups, leading to civil war and gradual "Yugoslavization," leaving no capacity to blockade the Strait. Core assumption: Brent peaks around $85/barrel by end-March, falling to around $70/barrel by June and remaining there. Scenario 3: Strait of Hormuz blockade lasts one month, followed by gradual reopening, potentially due to US military intervention securing the Strait or coordinated pressure from oil-consuming nations fearing recession. Core assumption: Brent peaks around $100/barrel by end-March, falling to around $70/barrel by September and remaining. Scenario 4: Protracted conflict, long-term Strait blockade, but limited spillover to neighboring producers. Core assumption: Brent rises to around $110/barrel by end-March and stays there. Scenario 5: Full-scale war involving US, Israel, Iran; long-term, comprehensive Strait blockade, with war spreading to oil producers. Core assumption: Brent surges to $150/barrel or higher. However, China's refined oil pricing mechanism includes a ceiling; when international prices exceed $130/barrel, retail fuel prices are not increased or are minimally adjusted. Thus, the effective impact assumes Brent reaches $130/barrel by end-March and stays there.

3. Assessment Results: If conflict escalates, full-year average PPI could reach 2.2%, CPI 2.1%; if conflict cools, PPI turns positive by May, averaging 0.4% for the year, with CPI at 1.0%. For PPI: Based on the scenarios, implied quarter-on-quarter Brent price growth rates are used to forecast PPI quarterly growth, ultimately deriving the full-year PPI year-on-year path via chain-linking. Key conclusions: If the US-Iran conflict de-escalates quickly and Brent returns to $65/barrel (Scenario 1), PPI year-on-year growth is highly likely to turn positive in May, averaging 0.4% for the year. If conflict escalates into full-scale war with a long-term Strait blockade (Scenario 5), significant imported inflation would occur. PPI year-on-year would rise steeply from Q2, peaking at 2.9% in August-September, averaging 2.2% for the year. Under any scenario involving a one-month Strait blockade (other scenarios), PPI year-on-year is highly likely to turn positive in March-April, averaging around 1% for the year. For CPI: If conflict de-escalates quickly, the 2026 CPI year-on-year average would be around 1.0%. If conflict intensity increases and the Strait blockade lasts longer, the CPI average could range between 1.3% and 2.1%.

Part 3: Converging Paths or Superficial Similarity? Oil-Price-Driven Inflation ≠ "Reasonable Price Recovery" The 2026 Government Work Report explicitly set a policy target of "around 2% growth in consumer prices" and to "shift the general price level from negative to positive and achieve a reasonable and moderate recovery in consumer prices." Policy deployment emphasized "considering the promotion of stable economic growth and reasonable price recovery as important factors for monetary policy." While rising oil prices pushing up PPI and CPI seem to align with this goal, a significant misalignment exists. Current domestic price weakness stems primarily from insufficient effective demand. The desired price recovery is "demand-pull inflation." In contrast, oil price hikes induce "cost-push inflation" or "imported inflation," originating from supply shocks.

1. Four Adverse Effects of Oil-Price-Driven Inflation First, cost-push inflation increases living costs, disproportionately impacting middle- and low-income groups. Unlike demand-pull inflation, which often accompanies rising incomes that can partially offset the impact on living standards, cost-push inflation directly raises living costs, creating a more palpable "pinch" for households. As energy and food constitute a larger share of spending for low-income families, oil-driven increases in transport and food prices (via agricultural inputs and logistics) erode their real purchasing power more significantly. Second, mid- and downstream enterprises may face a double squeeze from rising input costs and weak end-demand, leading to profit declines and weakened expectations. Oil price increases transmit downstream, raising costs for transport, chemical raw materials, and agricultural inputs. However, against the backdrop of weak end-demand, these businesses struggle to pass increased costs onto consumers, further compressing their profit margins. Even if some costs are eventually passed through, weak income expectations and low consumer confidence could further suppress consumption demand, also harming corporate revenue and profits. Third, imported inflation weakens China's terms of trade, increases foreign exchange outflow pressure, and poses challenges for RMB exchange rate stability. Terms of trade measure the ratio of export prices to import prices. As a major crude oil importer, higher oil prices increase import costs, weakening the terms of trade. This means China must expend more domestic resources or export more goods to maintain the same import volume. Simultaneously, significantly higher energy import bills pressure the current account, posing potential challenges to foreign exchange reserves and currency stability. Fourth, inflation driven by supply shocks could constrain further monetary policy efforts to stabilize growth. With the economic recovery foundation still unstable, appropriately accommodative monetary policy is needed, and market expectations for RRR and interest rate cuts are high. However, if oil prices push CPI significantly higher, especially above 2%, the central bank might face public and communication challenges regarding price stability when considering easing, complicating monetary policy operations and potentially interfering with normal macro-control.

2. Potential Positive Effects of Imported Inflation Amid Low Price Conditions During periods of previously high inflation in China, imported inflation like oil price spikes typically brought undesirable negative shocks, especially if coinciding with the "pig cycle" creating a "pig-oil resonance" driving high inflation. However, in the current context of persistently low prices, imported inflation might inadvertently have some positive effects. First, it could boost inflation expectations, alleviating the self-reinforcing cycle of low prices. Prolonged low inflation has led to subdued inflation expectations among microeconomic entities. If entrenched, this leads businesses and consumers to postpone investment and purchases, further depressing demand and making price recovery difficult. A rebound in PPI and CPI driven by oil prices, even if not signaling genuine demand improvement, could interrupt this self-fulfilling expectation process and reinforce the policy effect of promoting reasonable price recovery. Japan's exit from deflation post-1990s partly benefited from imported inflation pressure during the pandemic's supply chain disruptions and recent yen depreciation, which helped lift household inflation expectations. Second, it could improve upstream corporate conditions, lower real interest rates, and promote a virtuous economic cycle. While cost-push inflation may negatively impact mid- and downstream sectors, it helps upstream sectors like energy and chemicals stabilize first, improving profits and employee income, injecting vitality into the economic cycle. Furthermore, rising PPI helps lower real interest rates, reducing corporate debt burdens and stimulating credit and investment demand. Third, it could increase fiscal revenue, ease local government debt pressure, and expand fiscal policy space. Taxes like VAT and resource taxes are highly correlated with price levels. Rising PPI expands the tax base for industrial goods transactions, boosting fiscal revenue. Additionally, higher prices increase nominal GDP growth, improving local government debt-to-GDP ratios, easing debt pressures, and creating more room for proactive fiscal policy.

Part 4: How Should Policy Respond? In response to cost-push or imported inflation driven by oil prices, policy should avoid being misled by superficial price data and instead coordinate efforts across three fronts: buffering supply-side impacts, supporting affected microeconomic entities, and maintaining macro-policy resolve.

1. Enhance Energy Security on the Supply Side to Cushion Domestic Impact from International Oil Volatility First, flexibly utilize strategic petroleum reserves. Increase reserve purchases when prices are relatively low and release reserves to the market during sharp price spikes, acting as a stabilizer to "peak shaving and valley filling." Second, leverage the buffering function of the refined oil pricing mechanism. China's current mechanism includes features like a price ceiling; when international prices exceed $130/barrel, domestic refined product prices do not follow suit. This mechanism can weaken the transmission of extreme international prices to domestic end-prices, and its strict enforcement should be ensured. Third, accelerate diversification of energy import sources and development of alternative energies. Expand energy cooperation with regions like Russia, Central Asia, Africa, and South America. Accelerate the installation of wind, solar, and other renewables and energy storage. Promote electrification in transportation. These measures reduce the economy's sensitivity to international oil price shocks.

2. Provide Targeted Support and Subsidies to Enterprises and Households to Protect Businesses and Livelihoods First, implement targeted support for impacted mid- and downstream industries and SMEs. Sectors like transportation, logistics, downstream chemicals, and agriculture are directly hit. Consider temporary tax/fee reductions or provide special subsidies and loan interest discounts to help businesses weather the high-cost period, preventing widespread operational difficulties and unemployment. Second, provide targeted subsidies to middle- and low-income groups. Rising energy and food prices have a regressive effect, hitting low-income families hardest. Timely increases in subsistence allowances, one-off price subsidies, or consumption vouchers can protect basic livelihoods and quickly translate funds into consumption demand through groups with higher marginal propensities to consume.

3. Maintain Macro-Policy Strategic Resolve, Focus on Core CPI and Output Gap, Strengthen Expectation Management On one hand, macro-policies, especially monetary policy, should maintain strategic resolve, focusing on core CPI and the output gap rather than headline price indicators significantly disturbed by oil prices. Faced with supply shocks like oil price spikes, as long as the shock is temporary and does not trigger a wage-price spiral, monetary policy should not respond with tightening. The primary contradiction facing China's economy is insufficient effective demand. The main task of monetary policy remains maintaining ample liquidity, keeping overall financing costs low, and strengthening support for key areas like domestic demand expansion, technological innovation, and SMEs. On the other hand, relevant authorities need to strengthen expectation management to prevent market or public misinterpretation of data and policy. For instance, when releasing CPI and PPI data, statistical agencies could emphasize the trend in core CPI to help the market accurately interpret the price situation. The central bank can use channels like monetary policy reports and press conferences to clearly communicate that the current price recovery is primarily driven by external supply shocks and does not alter the accommodative stance of monetary policy, thereby stabilizing market expectations and preventing unnecessary speculation and volatility in financial markets regarding policy direction.