China reaction: CPI inflation improves but deflationary pressure remains

Deflationary pressure persists

China’s Consumer Price Index (CPI) inflation improved to 0.5% year on year in July, up from 0.2% in June, which aligned with our expectations but exceeded market predictions of 0.3%. On a monthly basis, the headline CPI inflation reversed a two-month consecutive decline, rising by 0.5% in July from -0.2% in June. The improvement was largely driven by food prices, with pork prices up 20.4% and vegetable prices increasing by 10.7%, pulling overall food prices out of a 12-month deflationary streak to 0.0% from -2.1% in June.

Core CPI, excluding food and energy, edged down to 0.4% from 0.6% in June. Service CPI inflation also eased slightly to 0.6% in July, down from 0.7% in June. Discretionary consumption remained sluggish. Prices for automobiles continued their decline, recording -5.6% in July, marking the 25th consecutive month of decrease, while home appliance prices fell further to -1.8% from -1.3% in June.

While the July CPI inflation figures show some improvement, these gains are primarily due to temporary, supply-side factors such as extreme weather affecting food supplies and seasonal demand from summer travel. With persistent sluggish wage growth and continued declines in housing prices, the outlook for CPI inflation remains weak. We maintain our forecast for an annual CPI inflation average of 0.6% for 2024.

PPI deflation sustained but better than expected

China’s Producer Price Index (PPI) deflation remained steady at -0.8% year on year in July, the same level as June, but better than the market expectation of -1.1%. Producer goods PPI improved slightly to -0.7% while consumer goods PPI extended its decline to -1.0% from -0.8% in June.

In the upstream sectors, prices for oil and gas extraction rose significantly, increasing by 6.7%, 3.0% month on month (June: 8.0% and -2.9%), supported by a recent spike in oil prices. However, prices for ferrous metal smelting and pressing fell further to -3.7% year on year, -1.7% month on month (June: -2.1% and -0.6%), largely due to ongoing issues in the property sector and possible disruptions from extreme weather. Downstream sectors showed modest signs of improvement, with automobile manufacturing prices rising by 0.2% on the month, although they remained down 2.1% year on year.

The improvement in PPI was largely driven by temporary factors such as the oil price rally, while fundamental issues like overcapacity and weak demand continued to exert downward pressure on factory gate prices. Looking ahead, the risks tilt to the downside, particularly with potential weakness in oil prices expected in August, and the underlying concerns about overcapacity and weak demand are unlikely to be resolved soon.

July’s Politburo shifts focus to domestic spending

In response to persistently weak domestic demand, Beijing allocated approximately RMB 300bn in special treasury bonds during July’s Politburo meeting. These bonds are part of a broader RMB 1trn ultra-long treasury bond package outlined in this year’s budget. Of the allocated funds, RMB 150bn will support trade-in programmes for automobiles, agricultural machinery, housing renovation, decoration and smart home appliances, while another RMB 148bn is designated for corporate equipment upgrades in key industries such as environmental infrastructure, transport, logistics, education, culture and healthcare.

While this initiative is a positive step for the economy, its impact is likely to be limited. The targeted items are primarily durable goods, which do not generate a sustained consumption stream. Moreover, the trade-in programme has little impact on improving the sluggish consumer confidence, which is vital for reviving long-term consumer spending. Addressing this would require tackling the underlying causes, including a bleak labour market outlook and ongoing property sector challenges.