Since July, renewed geopolitical tensions have caused oil prices to surge again, while the accelerated supply-side shakeout in midstream and downstream sectors represents a "hidden shift" the market has overlooked. Within this context, how many times will the annual inflation reading "peak"? This analysis provides a reference.

First Key Question: How does the renewed oil price surge impact PPI?

The rapid decline in oil prices earlier this period reflected overly optimistic expectations, which have been reversed by the price surge since July. After the US-Iran Memorandum of Understanding was signed in mid-June, oil prices briefly fell to around $70 per barrel, reflecting optimistic expectations about the reopening of the Strait of Hormuz. However, the reality is different. There are still many variables in US-Iran negotiations. Global crude oil inventories remain at historically low levels and have been accelerating their decline since June, indicating that the supply tightness is actually worsening. Against this backdrop, with the recent renewed blockade of the Strait of Hormuz, oil prices have surged again to above $90 per barrel.

International oil prices lead China's PPI by about half a month, and recent oil price volatility may cause PPI to show a pattern of "low in July, high in August." International oil prices affect China's PPI through the upstream-downstream transmission chain. Specifically, international oil prices lead the PPI for domestic oil and gas extraction by about half a month. The PPI for oil extraction influences the PPI for oil processing, which in turn affects the PPI for chemical products, rubber, and plastics, with transmission being largely simultaneous. From mid-June to the end of June, oil prices fell by nearly 20%, which will drag down the July PPI reading. Conversely, the rapid price increase since mid-July will push up the August PPI reading.

The current oil price rise may result in a "double peak" for the annual PPI, with the second peak (a year-on-year increase of 4.2%) potentially appearing in September. There are four major upside risks for future oil prices: historically ultra-low inventories, the expiration of the 120-day release plan from strategic reserves, the summer travel season combined with deferred demand recovery, and other geopolitical disruptions, such as from the Houthis. Under a baseline scenario, the PPI year-on-year rate is expected to fall to 3.6% in July, rise again to between 4.1% and 4.2% in August and September, and then fall back to 3.6% by year-end. In an optimistic scenario, the PPI peak is expected to be 4.1%, while in a pessimistic scenario, the peak is expected to be 4.4%.

Second Key Question: Will the midstream and downstream supply shakeout further elevate PPI?

The market has underestimated the impact of the supply shakeout on inflation. The earlier high oil price shock to the number of enterprises and employment in the petrochemical chain has accelerated this shakeout process, and it is already creating "stickiness" in midstream and downstream PPI. The operating rates of midstream and downstream petrochemical enterprises are near historical lows, and their actual inventories have turned to negative growth for the first time. The reason is that the previous oil price surge led to the "shakeout" of some enterprises. Employment in the petrochemical chain has fallen to around -2% year-on-year, and the number of enterprises has also turned negative for the first time. These supply shocks are difficult to recover from quickly. Reflected in prices, the PPI for the downstream petrochemical sector, which had weak pass-through ability due to overcapacity in the previous two years, has risen significantly to 10.3% since April, an increase greater than the historical pattern of upstream-to-downstream pass-through. In June, the year-on-year PPI for oil extraction fell sharply by 18.9 percentage points, while the midstream and downstream PPI fell by only 0.9 percentage points, demonstrating resilience.

Historically, every midstream and downstream supply shakeout has led to a "price increase" across the entire midstream and downstream chain, lasting from half a year to a year. This process does not end just because current oil prices fall. Over the past decade, there have been two rapid oil price increases, in 2017 and 2021-2022. When oil prices entered a declining phase, the upstream PPI of the petrochemical chain fell in sync, but the midstream and downstream PPI showed resilience, a pattern highly similar to the current situation. Each of those periods saw a rapid decline in midstream and downstream supply within the petrochemical chain, lasting six months to a year, and this phenomenon was observed across various sub-sectors.

The current round of midstream and downstream supply shakeout is more severe than in the past. Furthermore, leading indicators such as construction-in-progress suggest that future production capacity growth may also be trending downward, which could jointly support future midstream and downstream PPI. Before this round of oil price surges, the cost ratio for the midstream and downstream petrochemical chain (87%) had already reached a historical high, amplifying the supply shakeout caused by high oil prices. Construction-in-progress leads fixed assets by about one year. The negative growth rate of construction-in-progress in the second half of 2025 could lead to a decline in the fixed asset growth rate in the second half of 2026, supporting inflation. Market-observed capacity utilization rates may underestimate this trend due to numerator errors.

Third Key Question: Given the PPI "double peak," what is the trajectory for CPI?

The transmission path from PPI to CPI is "producer goods PPI → consumer goods PPI → core goods CPI," with a transmission lag of about four months. This logic has been accelerating. The transmission occurs in two stages. First, producer goods PPI transmits to consumer goods PPI (excluding food), with a four-month lag. Since January, the rapid increase in producer goods PPI has led to a rapid rise in the year-on-year rate for non-food consumer goods PPI since April, which rebounded from -1.5% in March to -0.1% in June. After non-food consumer goods PPI strengthens, it transmits to core goods CPI. During the same period, the year-on-year core goods CPI (excluding gold and silver jewelry) also rose from 0% to a relatively high level of 0.6%.

AI-related inflation has also strengthened the transmission effect from PPI to CPI, supporting downstream prices. The impact of AI inflation on PPI includes direct and indirect channels. The direct channel is the rapid increase in PPI for electronic components and computer and communication electronic equipment. The indirect channel is AI investment driving up non-ferrous metal prices, which in turn affects the PPI for related metal products and equipment. Estimates suggest that AI inflation contributes approximately 2.3 percentage points to the current year-on-year PPI. At the CPI level, AI inflation phenomena, such as memory price increases affecting PPI, are also influencing consumer goods prices like mobile phones, driving up the CPI for communication tools. Additionally, rising non-ferrous metal prices are indirectly affecting the CPI for some consumer goods like home appliances. Estimates suggest that AI inflation contributes approximately 0.2 percentage points to the current year-on-year CPI.

Conclusion

With oil prices surging again and the accelerated supply shakeout in midstream and downstream sectors, PPI may exhibit a "double peak" and CPI a "triple peak." Although end-consumer demand may be slow to recover, and the high base of gold prices will also drag on the CPI reading, the year-on-year CPI may generally trend downward in the second half of the year. However, under the disturbances of renewed oil price surges, the transmission of PPI to core goods CPI, and AI inflation, monthly CPI volatility may increase. The sharp drop in oil prices since June could drag the July CPI year-on-year rate down to a low of 0.5%, but it could surge again to 1% in August and September. The annual CPI year-on-year rate may show an "M-shaped" trajectory with three peaks: February (1.3%), April-May (1.2%), and September (1.0%).