China deflation risk grows as signs of economic weakness mount

China’s core inflation cooled to the weakest in more than three years, adding to signs policymakers are struggling to get households spending and further putting the annual growth target under pressure.

The consumer price index increased 0.6 per cent in August from a year earlier, less than a median forecast of 0.7 per cent growth in a Bloomberg survey of economists. Excluding volatile food and energy costs, core CPI rose 0.3 per cent, the least since March 2021, indicating lingering weakness in overall demand.

“The deflationary pressure in China is getting more entrenched,” Michelle Lam, Greater China economist at Societe Generale. “This may well fuel a downward price-wage spiral which will require more radical policy response.”

Factory-gate prices remained stuck in deflation, as they’ve been since late 2022, with the producer price index sliding 1.8 per cent from a year earlier, more than economists’ forecast of a 1.5 per cent drop.

The modest rise in consumer prices was driven by higher costs of food because of bad weather, Dong Lijuan, chief statistician at the National Bureau of Statistics, said in a statement accompanying the release. Fresh vegetables, in particular, saw prices rise by 18.1 per cent due to heavy rainfall. 

China’s economy is fighting the longest streak of falling consumer prices since 1999, according to a measure of economy-wide prices. Weak consumption and investment demand have led to intense price wars in sectors including electric vehicles and solar. This is denting China’s chances of hitting its growth goal of about 5%, as consumers delay purchases and businesses slash wages.

“The fiscal policy stance needs to become more proactive in order to prevent the deflationary expectations from becoming entrenched,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

The data suggest policy steps to shore up the economy — from a cash-for-clunkers program to rate cuts — have been inadequate to counter the drag from the slumping housing market and low confidence. We expect policymakers to increase support.

Former central bank Governor Yi Gang has called on policymakers to focus on fighting deflationary pressures “right now.” That marked a rare acknowledgment by a prominent Chinese figure of the nation’s battle with falling prices.

“Overall we have the problem of weak domestic demand, especially on the consumption and investment side, so that needs proactive fiscal policy and accommodative monetary policy,” 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 China Economist Hui Shan said that would be “challenging” because of poor sentiment and a lack of confidence about 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 space to cut the amount of cash banks must keep in reserve, according to Zou Lan, the central bank’s monetary policy department head who noted last week that the average reserve requirement ratio for financial institutions is at about 7 per cent. 

Analysts have been forecasting further rate cuts and a reduction to the RRR rate with September seen as a potential window.

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