In June, consumer prices in China teetered on the brink of deflation as producer prices dropped at their sharpest rate in more than seven years. This strengthens the case for officials to employ more stimulus to boost sluggish demand.

For the first time since February 2021, consumer prices are moving towards deflation, which is bad news for China’s economic growth. Factory-gate price deflation is also getting worse.

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 pickup witnessed in the first quarter.

“We think the more challenging deflation environment and sharp slowdown in growth momentum support our view that the PBOC has entered a rate-cutting cycle,” said economists at Barclays in a research note.

The National Bureau of Statistics (NBS) said on Monday that the producer pricing index (PPI) dropped for the ninth consecutive month in June, falling 5.4% from a year earlier, the biggest drop since December 2015. Comparatively, a Reuters poll of analysts predicted a 5.0% fall instead of the previous month’s 4.6% decline.

In contrast to the 0.2% increase in May, which was driven by a sharper decline in pork prices, the consumer price index (CPI) was flat year-over-year in June. That was below the 0.2% rise forecast and the slowest rate since February 2021.

Even accounting for a likely increase in service inflation because of the summer vacation period, Nomura anticipates a 0.5% annual decline in consumer prices in July.

The yuan dropped, and Asian stocks also took a hit as a result of the weaker-than-expected inflation data.

“We expect headline inflation to rise to around 1% by the end of this year. But this would still be soft and won’t constrain the PBOC’s ability to loosen policy further,” said economists at Capital Economics.

“That said, with credit demand weak, and the currency under pressure, we think the bulk of support will come through fiscal policy. We expect only another 10 basis points of policy rate cuts this year.”

Beijing has set a 2023 objective of 3% or less for the average consumer inflation rate. In 2022, prices increased 2% year over year.

China promised to take steps to encourage household consumption last month and slashed policy rates to increase liquidity.

Energy, metals, and chemicals experienced the largest year-over-year price drops due to weakening domestic and international demand.

“The accelerating decline in PPI reflects the still weak real estate and construction sector as well as the strength of industrial production,” said Bruce Pang at chief economist at Jones Lang Lasalle.

“However, the year-on-year decline in the PPI is likely to have bottomed out and is expected to narrow gradually in the second half of the year,” said Pang.

Hu Yuexiao, an analyst at Shanghai Securities, predicts decreases in the reserve requirement ratio and interest rates in the second half and believes the Chinese central bank will slash lending rates even further.

However, economists claim that tiny rate reductions won’t have a significant influence on loan demand as households and firms fix their COVID-damaged balance sheets and pay off their debts, requiring Beijing to rely on fiscal stimulus and other methods to increase demand.

(Adapted from Reuters.com)

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