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Consumer & Producer Prices (Jul.)

Factory-gate deflation returns

  • Weakening demand dragged producer price inflation into negative territory last month even as surging pork prices continued to push up consumer price inflation. Both have downbeat implications for the health of China’s economy.
  • Consumer price inflation continued climbing in July and reached a 17-month high of 2.8% (the Bloomberg consensus was +2.7%, our forecast was +2.9%). (See Chart 1.) Disruptions to pork supply caused by African swine fever remain the main driver of this trend as pork price inflation rose from 21.1% y/y to 27.0% last month. (See Chart 2.) Non-food inflation, however, was dragged down by declining energy prices. Core inflation (which strips out both food and energy prices) remained stable. With pork supply still collapsing, headline consumer price inflation looks set to climb further in the coming months.
  • Meanwhile, producer price inflation turned negative in July for the first time in three years, softening from 0.0% y/y to -0.3% (Bloomberg -0.1%, CE -0.4%). (See Chart 3.) This was largely the result of a further fall in raw material prices, reflecting the recent weakness in global commodity prices. But the prices of manufactured industrial inputs also fell, which suggests that demand for Chinese industrial output is waning. (See Chart 4.) Producer price deflation is likely to intensify in the coming quarters given that a downturn in property construction will probably weigh on Chinese steel prices, alongside the broader drags to industry from a wider slowdown in economic growth.
  • The upshot is that China faces the worse of both worlds. Accelerating consumer prices that will weigh on household confidence and real income growth, but at the same time, the return of factory-gate deflation that will put further downward pressure on manufacturing profits, which are already contracting. We think the People’s Bank will put more weight on the latter when setting policy, especially given that supply disruptions are mostly to blame for higher consumer price inflation. As such, we still expect additional monetary loosening.

Chart 1: Consumer Prices (% y/y)

Chart 2: Consumer Prices (% y/y)

Chart 3: Producer Prices

Chart 4: Producer Prices (% y/y)

Sources: CEIC, Capital Economics

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Julian Evans-Pritchard Senior China Economist
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