China is the wild card for global inflation in 2023

The broad view for next year is that inflation around the world will slow as interest rates rise, recession looms and consumers spend less. Cooling commodity, food and energy prices, magnified by the favorable comparison with last year's steep gains, will combine to slow the broad rate of inflation.

But China's reopening could rattle those expectations. The scenario goes like this: At some point in 2023, China opens its borders for the first time since the early days of the pandemic. The implications for the rest of the world would be seismic. China's domestic economy would come back to life. Students would go overseas again, tourists would start to travel, and business executives would get back on planes. This would be happening at the same time China's housing market starts to recover, further fueling consumer spending.

Bloomberg Economics reckons a China reopening would boost global commodity prices and could create supply chain backups that would put pressure on prices of many goods and services. Assuming China is fully open by mid-2023, Bloomberg Economics estimates energy prices will increase by 20% and the US consumer price index, which they believe may drop to 3.9% by midyear, may jump to 5.7% by yearend.

That would be a reversal of China's role this year, when it's helped keep a lid on global inflation. The housing slump and aggressive restrictions to contain Covid have caused an unusual slowdown in China's economy. Bloomberg Economics has lowered its gross domestic product growth forecast for 2022 to 3%, from 3.5%, and trimmed next year's projection to 5.1%, from 5.7%. A variety of indicators capture how China's weakness has affected every corner of the global economy.

The International Energy Agency in September said China's purchases of oil this year will be the lowest since 1990. China's imports from trade bellwether South Korea, its fifth-biggest trading partner, fell by more than 25% in November, the largest decline since 2009. Tough travel restrictions mean air traffic in China, the world's second-biggest air travel market behind the US, has sunk to 35% of what it was in 2019. China used to be the world's busiest domestic aviation market, handling about 14,000 flights a day. That was down to about 2,800 in November.

A rebounding China would drive up imports of oil, commodities and raw materials, while stoking demand for airline seats, hotel rooms and overseas real estate. "Surely it will push up global inflation if China reopens fully," says Iris Pang, chief economist for Greater China at ING Groep NV. "There will be more international travel, more sales, more production."

How likely China is to reopen next year remains an open question, but it's clear a pivot is underway. On Dec. 7, authorities in Beijing issued a 10-point plan that included additional easing measures, cementing a view among observers that the government is moving away from Covid Zero.  Beijing, Guangzhou, Hangzhou, Shanghai and Shenzhen are among the cities that have eased curbs even as cases soar. Restrictions are being rolled back in Zhengzhou, home to Apple Inc.'s largest Chinese manufacturing site. Vice Premier Sun Chunlan has said the country's pandemic control has entered a new phase. All of which is stoking expectations that China will shift to reopen sooner than had been expected. Christopher Beddor, an analyst at Gavekal Inc., says recent policy steps demonstrate that the government's Covid policy is evolving. "China has arrived at the beginning of the end of Zero Covid," he says.

Before the economic recovery comes, China faces the threat of a public-health crisis. A lack of intensive-care hospital beds leaves it facing a complicated exit from Covid Zero that may well stretch beyond 2023. A full reopening may lead to 5.8 million people being admitted to intensive care, overwhelming a system with less than 4 ICU beds per 100,000 people, far fewer than in developed countries, according to Bloomberg Intelligence senior pharmaceutical analyst Sam Fazeli.

That's why most analysts expect China to navigate a slow, careful and complicated reopening that may mean continuing disruptions to mobility, supply chains and consumer confidence. A major test of China's new approach to the virus will come in January during the Lunar New Year holiday. Authorities may enforce strict travel restrictions or testing requirements that could dampen the holiday mood and reinforce the idea that the road out will be bumpy.

Despite the uncertainties, markets are rallying on more signs that government policy toward the virus is shifting. Hong Kong's Hang Seng China Enterprises Index surged 29% in November, for its best month since 2003, and the benchmark Hang Seng Index had its biggest monthly gain since 1998. In an example of the spillover effect, Australia's stock market hit a seven-month high on news of China's shifting stance.

There's another reason China may be an inflationary force next year: property. A flurry of measures to stabilize house prices were announced in recent weeks, including loosening down-payment requirements for homebuyers and taking steps to ease the liquidity crisis among developers. While these actions don't guarantee a strong rebound for the real estate sector, which by some estimates accounts for up to 25% of China's economy, they could be enough to get GDP growth back on track.

That possible combination of a recovering housing market and a reopening would have knock-on consequences for China's trading partners and financial markets. A recent paper by the New York Federal Reserve, "What Happens in China Does Not Stay in China," found that the country plays a crucial role in global consumption, growth and investors' animal spirits. "Specifically," they wrote, "we find that expansionary credit policies in China lead to notable increases in commodity prices, global production, and GDP outside of China driven by higher Chinese demand."

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.