China Deflation Provides Limited Relief for Global Central Banks

(Bloomberg) — China’s consumer and producer prices fell together for the first time since 2020, a deflation cycle that could give global central banks some help in fighting inflation in their own countries but signals a worsening outlook in the world’s second-largest economy. 

(Bloomberg) — China’s consumer and producer prices fell together for the first time since 2020, a deflation cycle that could give global central banks some help in fighting inflation in their own countries but signals a worsening outlook in the world’s second-largest economy. 

The consumer price index registered its first decline in more than two years, falling 0.3% in July from a year earlier, the National Bureau of Statistics said Wednesday. Producer prices fell for a 10th consecutive month, contracting 4.4%.

Slowing consumer demand in China combined with a property slump as well as rapidly falling exports are pushing manufacturers to cut prices to get rid of excess stock. That could ripple through to developed countries, where central banks like the Federal Reserve and Bank of England are still hiking interest rates to tame elevated inflation.

Deflation in China “should help inflation in the US and Europe to moderate,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. 

But with politics in many developed countries becoming more protectionist, not everyone will welcome cheaper Chinese goods into their markets. The European Union’s trade chief this week vowed to press China to reduce its trade surplus with the bloc, earning a rebuke from Beijing, which said the EU’s export restrictions were at fault.

In developed countries “cheap consumer goods from China aren’t looked on as favorably as before,” said Paul Cavey of consultancy East Asia Econ. Emerging markets might welcome lower prices for machinery, but also worry about Chinese competition undercutting their efforts to develop domestic industries, he added.

While deflation will help to bring down some global prices, the impact on inflation rates in developed economies could be limited since imports from China make up a relatively small share of consumer spending compared with locally-produced services in those countries.

Economists see China’s falling prices as a warning sign about economic growth, as goods supply continues to outrun demand. And while policymakers have pledged to support the recovery, they’ve signaled they won’t provide stimulus as large as during previous downturns. 

“China is in deflation for sure,” Robin Xing, chief China economist at Morgan Stanley, said in an interview with Bloomberg TV. Policymakers “need to accelerate all the government spending, raising government debt and do coordinated monetary and fiscal easing, to break this debt deflation trap,” he said.

Deflation could slow China’s economy as falling prices lead consumers to delay purchases of durable goods. For companies, falling prices can reduce investment by increasing debt costs relative to income, a process known as “debt deflation.”

A rise in inflation-adjusted interest rates means there’s scope for China’s central bank to ease monetary policy, including cutting the amount of cash banks need to keep on reserve and increasing lending through state-owned policy banks, said Bruce Pang, head of research and chief economist for greater China at Jones Lang LaSalle Inc. 

But several factors will limit the scope of stimulus, according to economists.

First, the outlook for prices is improving. Much of the decline was driven by a high base of comparison from mid-2022 when lockdowns pushed up food prices. Global commodity prices are also down compared to last year.

“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.

China’s measure of core inflation, which strips out volatile food and energy costs, also improved in July to 0.8%. A breakdown of the consumer inflation figures showed prices of services spending, like recreation and education, continued to climb.

“We expect CPI will be negative only for the short term, like for one to two months,” said Standard Chartered’s Ding. “The drag on CPI seen in the first half from food and fuel will likely ease.”

PPI deflation is also easing, with July’s contraction smaller than the previous month. 

What Bloomberg Economics Says … 

“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 stabilize as base effects turn more favorable. Stepped-up policy support for the economy will probably help prices rebound in the second half the year.”

— Eric Zhu, economist 

Read the full report here. 

Other factors holding authorities back from further policy loosening is a weaker yuan and concerns that money released into the banking system by the People’s Bank of China will be stuck there, rather than used to fund productive activity. 

Reluctance to expand production among Chinese firms “drove them to put loans obtained immediately into deposits,” the Economic Daily newspaper, affiliated with China’s State Council, wrote in a front-page article on Wednesday. Liquidity is “flush” in the financial system, it added.

Market reaction was muted. The Hang Seng China Enterprises Index trimmed an earlier loss of as much as 0.9% to trade little changed as of 3:17 p.m. local time. The onshore benchmark CSI 300 Index of stocks ended the day 0.3% lower. The yuan traded offshore gained 0.2% to reach 7.2217 per dollar.

The fall in the CPI was widely expected, especially after China published second quarter GDP data which implied that the deflator — the broadest measure of prices in the economy — turned negative for the first time since 2020.

This is only the fourth time this century that China has reported deflation by that measure. Beijing responded to previous deflationary periods in 2009, 2015 and 2020 with forceful monetary easing and large fiscal stimulus.

While Beijing has vowed to accelerate infrastructure investment and increase support for a slumping housing market, economists aren’t expecting a large-scale stimulus as Beijing focuses on shifting its economy toward new growth drivers. 

That would make Beijing’s response more similar to its response to a 1998 period of deflation, which is now remembered as structural. Beijing recapitalized underperforming banks and downsized its state-sector ahead of joining the World Trade Organization.

The lack of large-scale stimulus is why economists are trimming their expectations for GDP growth this year close to China’s official target of around 5%. Some see that target at risk due to a faster than expected drop in exports and a weakening housing market. Home prices in China have been falling since last year, the first time that’s happened since 2015.

“The government for now wants to focus on a structural response. But I’d argue that won’t be enough,” Cavey said.

–With assistance from Zhu Lin and Wenjin Lv.

(Updates with additional details.)

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