In June, consumer inflation in China fell to its lowest level since 2021, while factory-gate prices dropped at the sharpest rate in seven and a half years. This strengthens the case for officials to employ more stimulus to boost sluggish demand. Concerns over the health of the second-largest economy in the world have been raised as momentum in China’s post-pandemic recovery has slowed from a rapid rise witnessed in the first quarter.
China’s Producer Price Index (PPI) experienced its sharpest decline since December 2015, falling for the ninth consecutive month in June. The PPI dropped by 5.4% compared to the previous year, exceeding the 4.6% decline from the previous month and the 5.0% forecasted by Reuters analysts. In contrast, the Consumer Price Index (CPI) remained unchanged year-on-year, deviating from the expected 0.2% rise due to a faster decline in pork prices. These lower-than-anticipated inflation figures had a negative impact on financial markets, causing the yuan to weaken and Asian stocks to decline.
Economists at Capital Economics anticipate a gradual increase in headline inflation to around 1% by the end of the year, which would not impede the People’s Bank of China (PBOC) from further loosening monetary policy. Given weak credit demand and currency pressure, fiscal policy is expected to be the primary means of support. Capital Economics projects only a marginal reduction of 10 basis points in policy rates for the remainder of the year.
Beijing has set a target of approximately 3% for average consumer inflation in 2023, following a 2% year-on-year price increase in 2022. China recently implemented rate cuts to enhance liquidity and pledged measures to stimulate household consumption.
The largest declines in producer prices were observed in the energy, metals, and chemicals sectors, reflecting weakened domestic and foreign demand. Bruce Pang, chief economist at Jones Lang Lasalle, attributes the accelerated decline in the PPI to the persistent weakness in the real estate and construction industry, along with the robustness of industrial production. Pang predicts that the year-on-year decline in the PPI has likely reached its lowest point and expects a gradual narrowing in the second half of the year.
Hu Yuexiao, an analyst at Shanghai Securities, suggests that China’s central bank will likely further reduce lending rates and implement cuts to the reserve requirements ratio and interest rates in the second half of the year. However, economists caution that these modest rate cuts may not significantly impact loan demand, as households and businesses focus on recovering from the economic repercussions of the COVID-19 pandemic, including repairing balance sheets and repaying debts. Consequently, Beijing will likely rely on fiscal stimulus and other measures to stimulate demand.