The risk of deflation in China is rising as signs of economic weakness grow

(Bloomberg) — China’s core inflation fell to its weakest in three years, fueling calls for more efforts to boost household spending as weak demand puts annual growth target under pressure.

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The consumer price index, excluding volatile food and energy costs, rose just 0.3 percent in August from a year earlier, the lowest level since March 2021, the Office for National Statistics said on Monday. Broader CPI rose 0.6 percent, missing expectations, even as it was supported by higher food costs due to bad weather last month.

Taken together, the figures provide further evidence of weak consumer demand in the world’s second-largest economy, prompting calls for more measures to prevent a downward spiral in corporate incomes, wages and spending.

“Deflationary pressure in China is becoming more entrenched,” said Michelle Lam, Greater China economist at Societe Generale. “This may fuel a downward price-wage spiral that will require a more radical policy response.”

China’s CSI 300 extended early losses to end the morning session down 1.1 percent. The onshore benchmark is poised to fall to a five-year low as bearish sentiment persists amid a lack of earnings and economic recovery.

The yuan posted small losses in both onshore and offshore transactions. China’s 10-year government bond yield was little changed at 2.13 percent, near a record low.

China’s economy is struggling with its longest streak of falling prices since 1999, according to the gross domestic product deflator, a measure of economy-wide prices.

Weak consumption and investment demand have led to intense price wars in sectors including electric and solar vehicles. That hurts China’s chances of reaching its growth target of about 5 percent as consumers delay purchases and companies cut wages.

Vehicle prices fell 5.5 percent, while those of phones and other communications equipment fell 2.1 percent, according to official data.

“The stance of fiscal policy needs to become more proactive to prevent deflationary expectations from strengthening,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

The modest increase in consumer prices was driven by higher food costs due to hot weather and heavy rains, Dong Lijuan, chief statistician of the NBS, said in a statement accompanying the release.

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Fresh vegetables in particular saw their prices increase by 21.8% compared to the same period last year, contributing 0.44 percentage points to the CPI.

What Bloomberg Economics Says…

The data suggest that policy steps to support the economy — from a cash-for-money program to rate cuts — have been inadequate to counter the strength of the falling housing market and low confidence. We expect policy makers to increase support.

David Qu, economist

Read the full memo here

Factory-gate prices remained stuck in deflation, as they have been since the end of 2022, with the producer price index falling 1.8% from a year earlier, more than economists had forecast for a 1.5% decline .

Former central bank governor Yi Gang last week urged policymakers to focus on fighting deflationary pressures “right now.” It marked a rare acknowledgment by a prominent Chinese figure of the nation’s battle with falling prices.

“In general, we have the problem of weak domestic demand, especially in terms of consumption and investment, so proactive fiscal policy and accommodative monetary policy are needed,” Yi said at the Bund Summit in Shanghai on Friday.

Yi said he hoped the GDP deflator, a broad measure of prices, would turn positive in the next few quarters. But Goldman Sachs chief economist Hui Shan said that would be “challenging” because of weak sentiment and a lack of confidence in the future.

“Organic private demand seems to be weakening more than we would like to see, but at the same time policymakers are getting uncomfortable,” she said in a Bloomberg TV interview.

The People’s Bank of China still has room to reduce the amount of cash banks must hold in reserve, according to Zou Lan, head of the central bank’s monetary policy department, who noted last week that the average reserve requirement ratio for financial institutions is of approximately 7%.

Analysts have forecast further interest rate cuts and a cut in the RRR rate, with September seen as a possible window.

(Updates with more details on price and market reaction. An earlier version corrected Zou Lan’s comments.)

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