China slides into deflation as consumer and factory prices fall

Investors expect the country's central bank to cut interest rates in order to add monetary stimulus

A supermarket attendant puts price tags on beverages at a supermarket in Beijing. China's consumer price index declined 0.3 per cent in July compared to last year, the National Bureau of Statistics said. EPA
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China’s consumer and producer prices both declined in July compared with a year ago, a sign of deflation that is likely to be temporary as policymakers face pressure to step up monetary and fiscal support.

The consumer price index dropped 0.3 per cent last month from a year earlier, the National Bureau of Statistics said Wednesday, marking its first decline since February 2021. Economists surveyed by Bloomberg had predicted a 0.4 per cent decline in prices.

Producer prices fell for a 10th consecutive month, contracting 4.4 per cent in July from a year earlier, slightly worse than expected. This marks the first time since November 2020 that both consumer and producer prices have registered contractions.

China is experiencing a rare period of falling prices as consumer and business demand weakens after an initial burst in the first quarter following the ending of pandemic restrictions. A prolonged property market slump, plunging demand for exports and subdued consumer spending are weighing on the economy’s recovery.

“China is in deflation for sure,” Robin Xing, chief China economist at Morgan Stanley, said in an interview with Bloomberg TV. “The question is how long. It’s up to the policymakers – will they react with co-ordinated fiscal and monetary easing.”

Using the gross domestic product deflator – a measure of economywide prices – China was in deflation in the first half of the year. The International Monetary Fund defines deflation as “a sustained decline in an aggregate measure of prices,” such as the CPI or GDP.

Unlike the temporary drops in consumer prices in late 2020 and early 2021, which were driven by falling pork prices, this contraction is driven by longer-term factors such as falling external demand and the property downturn. With export prices falling, China is set to pass on deflationary pressure to other countries via its massive goods trade.

Investors are betting the weak inflation data will prompt the People’s Bank of China to add more monetary stimulus, like cutting interest rates.

However, the central bank is facing several constraints that are making it cautious, such as a weaker yuan and elevated debt levels in the economy. Fiscal support has also been moderate, given the financial pressures many local governments are facing.

“They need to accelerate all the government spending, raising government debt and do co-ordinated monetary and fiscal easing, to break this debt deflation trap,” said Mr Xing.

The Hang Seng China Enterprises Index trimmed an earlier loss of as much as 0.9 per cent to trade 0.5 per cent lower as of 10.23am local time, while the onshore benchmark CSI 300 Index of stocks fell 0.2 per cent. The yuan traded offshore was little changed after the data release, holding its morning gain of 0.1 per cent at 7.2283 per dollar.

The statistics bureau attributed the decline in consumer prices to the high base of comparison with last year, saying the contraction is likely to be temporary and consumer demand continued to improve in July.

“With the impact of a high base from last year gradually fading, the CPI is likely to rebound gradually,” Dong Lijuan, chief statistician at the NBS, said in rare additional comments to accompany the official data.

PBOC officials said last week that China will avoid deflation in the second half of the year, with consumer price growth likely to trend closer to 1 per cent by the end of the year.

Food Prices

The core inflation measure, which excludes volatile food and energy costs, picked up to 0.8% from 0.4%, a sign of underlying – although subdued – demand in the economy. A breakdown of the consumer inflation figures showed prices for household goods, food and transport contracted, while prices of services, like recreation and education, climbed.

“We expect the CPI will be negative only for the short term, like for one to two months,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered.

“Food and energy prices are more likely to go up instead of going down in the second half of the year. That means the drag on the CPI seen in the first half from food and fuel will like ease.”

While the PPI has likely bottomed out, “it will be rather hard to emerge from deflation in the rest of the year,” he said.

“Details in the data suggest this marks a nadir. A month-on-month rise in the CPI and a pickup in the core gauge are early signs that CPI inflation is bottoming out. The PPI is starting to stabilise as base effects turn more favourable. Stepped-up policy support for the economy will probably help prices rebound in the second half the year,” Bloomberg Economics' Eric Zhu said.

Updated: August 09, 2023, 4:09 AM