China’s factory deflation steepens at the fastest pace in seven years in May

China’s factory gate prices fell at the fastest pace in seven years in May and quicker than forecasts, as faltering demand weighed on a slowing manufacturing sector and cast a cloud over the fragile economic recovery.

As rising interests rates and inflation squeeze demand in the United States and Europe, China is in contrast battling a sharp decline in prices with factories receiving less for their products from key overseas markets.

The producer price index (PPI) for May fell for an eighth consecutive month, down 4.6 per cent, the National Bureau of Statistics (NBS) said on Friday. That was the fastest decline since February 2016 and bigger than the 4.3 per cent fall in a Reuters poll.

“The risk of deflation is still weighing on the economy,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management, in a note. “Recent economic indicators send consistent signals that the economy is cooling,” he added.

China’s economy grew faster than expected in the first quarter, but recent indicators show demand is rapidly weakening with exports, imports and factory activity falling in May.

The consumer price index (CPI) rose 0.2 per cent year-on-year, speeding up from a 0.1 per cent rise in April but, missing a forecast for a 0.3 per cent increase.

Food price inflation, a key driver of CPI, slowed to 1.0 per cent year-on-year from 2.4 per cent in the previous month. On a month-on-month basis, food prices fell 0.7 per cent.

The Australia dollar eased 0.2 per cent to $0.6704, tracking a fall in the Chinese currency yuan after the inflation data.

The government has set a target for average consumer prices in 2023 to be about 3 per cent. Prices rose 2 per cent year-on-year in 2022.

“We still think a tightening labour market will put some upward pressure on inflation later this year, but it will remain well within policymakers’ comfort zone,” said Julian Evans-Pritchard, head of China economics at Capital Economics in a note.

“The government’s ceiling of ‘around 3.0 per cent’ for the headline rate is unlikely to be tested and we doubt inflation will become a barrier to increased policy support,” he added.

Policymakers have repeatedly signalled their intention to lean on China’s 1.4 billion consumers, after the economy last year reported one of its slowest paces of growth in nearly half a century.

“So far, monetary policy and fiscal policy have remained tight, along with lower income growth, so domestic demand is depressed,” said Dan Wang, chief economist at Hang Seng Bank China. Some economists expect the People’s Bank of China (PBOC) to cut rates or release more liquidity into the financial system. The bank cut lenders’ reserve requirements ratio in March.

China’s biggest banks on Thursday said that they had lowered interest rates on deposits, providing some relief for the financial sector and wider economy by easing pressure on profit margins and reducing lending costs.

Analysts have been downgrading their forecasts for economic growth for the year amid continued signs of slowing. The government has set a modest GDP growth target of around 5 per cent for this year, after badly missing the 2022 goal.

Meanwhile China’s economic growth is expected to be “relatively high” in the second quarter compared to the prior year, mainly due a low base of comparison, while consumer inflation is projected to be above 1 per cent by December, the central bank governor said.

As rising interests rates and inflation squeeze demand in the United States and Europe, China’s core CPI has been soft and factory gate prices fell sharply in May, suggesting the world’s second-largest economy is losing steam.

Some analysts have predicted the central bank may begin to cut key rates as soon as next week after a flurry of weak data highlighted the fragility of China’s economic rebound.

At present, China’s economy is recovering from the impact of COVID-19, and the balance sheets of its companies are being repaired, the People’s Bank of China (PBOC) said in a statement on Friday, citing Governor Yi Gang during his trip to Shanghai.

“It is expected that year-on-year growth of gross domestic product (GDP) in the second quarter will be relatively high (mainly due to the base effects). The CPI is expected to gradually pick up in the second half of the year and be above 1 per cent year-on-year by December,” the PBOC statement quoted Yi as saying.

China’s economy is facing challenges including rapidly worsening exports, a high youth jobless rate, property distress and weak domestic demand, but Yi said China is confident and capable of meeting the growth goals set earlier this year. The government has set a modest GDP growth target of around 5 per cent for this year, after badly missing the 2022 goal. First-quarter growth was better than expected at 4.5 per cent. The PBOC will continue to implement a prudent monetary policy, step up counter-cyclical adjustments, support the real economy and safeguard financial stability, the statement said.