21 Commentary | China Has Sufficient Policy Tools to Address External Price Shocks

Recently, the Federal Reserve announced that the federal funds rate will remain unchanged at 3.50%–3.75%. The Middle East conflict and its impact on the Strait of Hormuz have disrupted global oil markets and may keep inflation above the Fed’s 2% target. The Fed’s post-meeting statement clearly indicated that this conflict introduces new uncertainties.

In fact, the process of cooling U.S. inflation had already slowed significantly, but short-term inflation expectations have risen again in recent weeks. Powell acknowledged that price pressures from U.S. tariffs are gradually passing through to core inflation, and rising energy prices due to the Middle East situation add new upside risks. He also emphasized that it’s still difficult to determine how long this round of shocks will last and how severe their impact will be, but the potential threat to the U.S. and global economy should not be underestimated.

Previously, markets widely expected the Fed to start preemptive rate cuts in the first half of 2026 to counter potential economic slowdown. However, recent volatile economic data and the sudden escalation of geopolitical risks have quickly cooled this expectation. The likelihood of rate cuts in the near term has greatly diminished, and market focus has shifted to whether the U.S. economy will fall into a stagflation scenario.

Looking back to 2022, chip shortages caused a sharp rise in U.S. auto prices, serving as an early signal of the inflation cycle. The subsequent outbreak of the Russia-Ukraine conflict triggered a global energy price spike, compounded by ongoing supply chain disruptions and overheated demand driven by U.S. fiscal stimulus, creating a high inflation cycle that lasted for years.

Today, U.S. supply-side pressures have reemerged—energy prices are soaring due to Middle East tensions, and prices for key raw materials like chips are rising. Meanwhile, the pass-through effect of U.S. tariffs continues. But unlike 2022, demand in the U.S. has significantly cooled and does not have the same “overheating” foundation. Therefore, the likelihood of a repeat of the 2022 “widespread price surge” is lower. However, this does not mean the alarm is off. The current inflation pressures are set against a completely different macro environment, and the real risk lies in the formation of stagflation.

Earlier, markets were optimistic that the recent rise in oil and gas prices was a short-term shock, mainly because the transportation issues in the Strait of Hormuz were seen as more related to geopolitical uncertainties, with room for negotiations. But on March 18, direct attacks on oil and gas facilities by both sides in the conflict caused short-term capacity disruptions. This indicates that a substantial energy supply gap is expanding, not just transportation delays.

Thus, the nature of the energy shock is shifting from “temporary disturbance” to “persistent pressure.” If U.S. inflation rises again, the Fed will face a more challenging situation than in 2022. Back then, rising prices coincided with strong economic growth, a booming labor market, and room for continued rate hikes. Now, the U.S. Q4 2025 real GDP growth rate has been sharply revised down to 0.7% annualized quarter-over-quarter, well below the initial 1.4% and market expectations of 1.5%. Meanwhile, non-farm payrolls unexpectedly declined by 92,000 in February, and the unemployment rate rose to 4.4%. Data from the previous two months was also revised downward by 69,000.

These figures outline a typical stagflation scenario of “inflation rebound and growth slowdown.” This pattern not only narrows the window for rate cuts but could also cause the Fed to lose policy maneuverability. If inflation rebounds rapidly, the stock market bubbles accumulated over the past few years could face severe damage. Additionally, the resurgence of inflation would further fracture the already fragile “K-shaped recovery” in the U.S.: asset prices falling would hit high-income groups, while middle- and low-income populations would continue to bear the brunt of rising living costs, ultimately weakening the economy’s reliance on consumption.

Globally, the impact of this energy shock on China is expected to be relatively limited. Unlike Europe, the U.S., and Japan, oil and natural gas account for a smaller share of China’s power generation, and China has large strategic reserves and relatively diversified and stable import sources. However, the uncertainty in commodity supplies could influence domestic markets through expectations, as reflected in recent stock market volatility.

Based on past resilience, China has the capacity to absorb external price shocks. From a policy perspective, China also has the tools to do so. On March 18, the People’s Bank of China explicitly stated that it will continue to implement moderately loose monetary policy and firmly maintain the stability of stock, bond, and foreign exchange markets. This indicates that China has sufficient policy tools and institutional foundations to ensure economic and financial market stability.