Weaker-than-expected consumer price increases in May and the 20th consecutive month of declining manufacturing prices heightened concerns on June 12 about China’s ability to overcome persistently low domestic demand and investor pessimism.
The consumer price index (CPI) rose by 0.3 percent in May from the previous year, mirroring April’s increase, according to data from the National Bureau of Statistics released on June 12. This fell short of the 0.4 percent increase expected in a Reuters poll.
The producer price index (PPI), however, which has been in deflation since September 2022, continued to decline, although at a slower rate of 1.4 percent in May after a 2.5 percent drop in April, compared to the predicted 1.5 percent decline as Chinese industry received a boost from strong exports last month.
While the data showed some improvement from previous months, as the world’s second-largest economy faced the threat of deflation, the June 12 release highlighted a still-uncertain economic outlook.
“We think the still-subdued headline CPI inflation and softening core CPI reading painted a picture of continued weakness in domestic demand and private consumption,” Barclays FICC Research said in a note on June 12.
While China has experienced its longest deflation stretch since the global financial crisis of 2008–2009 through January 2024, the communist regime has struggled to boost consumer spending amid a prolonged real estate downturn and a grim labor market. Businesses are also hesitant to invest because of falling producer prices, which are eroding their profitability.
These trends, according to the UK-based investment bank, have also lowered investor expectations for a quick rebound in inflation, particularly because of significant administrative price increases in utilities and train tickets.
“We think the higher costs [and] spending for utilities and train fares will squeeze spending on other discretionary items, especially given the deteriorating labor market and wage growth,” the note stated.
Since 2023, weak consumption in China has suppressed consumer prices despite multiple support measures, as confidence remains because of a prolonged property sector crisis.
Analysts say that to sustainably boost demand, China urgently needs a new round of stronger and more coordinated fiscal and monetary stimulus.
Overcapacity Concerns
Experts say that the June 12 data on core inflation, which excludes the volatile food and energy sectors, highlighted the challenge Beijing faces in trying to boost domestic demand.Although producer prices rose for the first time in eight months and consumer price inflation remained steady in May, persistent overcapacity continues to plague the economy and is likely to cause deflation in the foreseeable future.
“The pick-up in factory-gate prices is likely temporary, due to overcapacity, [and] they will probably resume their declines before long, keeping PPI inflation in negative territory for the rest of the year,” Capital Economics said in its reaction on June 12.
“Persistent overcapacity will likely keep the CPI inflation rebound modest [as well].”
According to Capital Economics, China’s inflation data suggest a structural imbalance between supply and demand, primarily affecting the consumer market.
Since the COVID-19 pandemic began, production capacity has expanded rapidly, with the value of fixed assets among manufacturers, or production capacity, in other words, having increased by more than 30 percent since 2019.
The pandemic’s surge in global demand for consumer goods initially drove this expansion. However, even as global demand normalized and declined, policy support maintained strong manufacturing investment, especially in sectors deemed strategically important by the government.
Fundamentally, this persistent imbalance is a consequence of dedicating a very high share of national income to investment, despite the economy’s diminishing ability to absorb rapid capital accumulation due to demographics and other structural trends, the research firm states.
It adds that the rapid supply-side expansion, combined with the softening of global demand post-pandemic and sluggish domestic consumption growth, led to widespread overcapacity.
Consequently, Barclays noted that the consumer-products PPI, which has been in contraction for 16 months, has barely improved at minus 0.8 percent from the previous year, following a 0.9 percent decline the prior month.
“The lingering consumer goods deflation may highlight the combination of weak demand and excess capacity issues. This is another sign that manufacturers may not be able to pass higher input costs fully on to consumers,” the Barclays note said.
Looking ahead, Barclays projects that the recovery in consumption will remain hindered by labor market weaknesses stemming from uncertain employment and income prospects, negative wealth impacts, and strained household finances.
“These drags on consumption, and hence, CPI, in our view, are likely to extend to 2025. As a result, we lower our 2025 full-year CPI inflation forecast to 1.2 percent from 2.0 percent previously,” the note concluded.
