(July 15): China ended a record deflationary run last quarter, although the rebound of a key price gauge was driven by surging global energy costs rather than a recovery in domestic consumption.
The so-called GDP deflator, which measures price changes across all domestically produced goods and services, rose 1.6% in the second quarter after three years of contraction. But the turnaround brings little comfort for an economy that slowed in the April-June period to the weakest pace since the last months of 2022.
“The higher price level is cost-push — we can call this ‘bad inflation'," said Raymond Yeung, chief economist for Greater China at ANZ. Still, he added that positive inflation expectations are better for the economy than remaining stuck in a persistent deflationary trap.
The positive figure, calculated by Bloomberg News based on government data released Wednesday, is a significant milestone in exiting a spiral of declining prices due to manufacturing capacity far in excess of consumer demand.
But economists warn that the reversal may not be sustained as price increases are largely limited to oil and sectors linked to artificial intelligence.
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“China is mainly experiencing imported inflation, as oil prices lifted producer prices,” said Larry Hu, head of China economics at Macquarie Group. He noted this cost shock dragged down industrial production and sent the volume of retail fuel sales plunging about 20% from a year ago.
This supply-side pain is also visible in fixed-asset investment in the manufacturing sector, which declined 1.2% overall in the first half of the year in the worst drop seen outside the pandemic.
The external price pressure likely worsened domestic consumer weakness, keeping retail sales growth for the first six months at a meagre 1.3%. The drag from a property slump also persisted, with real estate investment falling 18% during the period.
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The GDP deflator shows how much of the increase in non-inflation-adjusted growth is due to higher prices rather than greater economic activity. China’s statistics authority does not publish the official deflator and economists calculate it by subtracting real GDP growth from nominal growth.
Ding Shuang, chief economist for Greater China and North Asia for Standard Chartered plc, called the positive deflator welcome regardless of its drivers. He warned, however, that China’s immense production capacity and weak consumption mean it remains a force of global disinflation.
China has largely shielded itself from the massive run-up in oil prices stemming from the war in Iran through its own reserves — the biggest strategic inventory in the world. It’s also importing less oil, with inbound shipments sinking in June to a 10-year low.
Data out last week showed that consumer inflation and the core gauge of prices both slowed more than expected in June from a year earlier, a sign that China’s reflationary momentum is peaking. With Middle East tensions still high and oil prices flaring up again, it’s possible that China could experience some fresh inflationary pressure at least in the near term.
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