Softening data
China’s consumer price index (CPI) fell 0.2% month-on-month in June, contributing to the year-on-year (YoY) inflation rate declining from 0.3% to 0.2% (see Chart 1).
Investment Insights • MFN
6 min read
China’s softening data makes the case for further policy support
Chinese inflation and GDP data were weak in Q2, highlighting subdued domestic demand. In this Macro Flash Note, Economist Sam Jochim assesses the recent data and policy implications.
Chart 1. China CPI inflation (% change, YoY)
Source: LSEG Data & Analytics and EFGAM calculations. Data as at 24 July 2024.
Food and non-food inflation were both weak in YoY terms in June and have been for some time. Within non-food inflation it was notable that vehicles and household appliances registered YoY price decreases, despite being areas in which the Chinese Communist Party has aimed to support demand in 2024.1
Further evidence of subdued domestic demand was on display in Q2’s GDP data. Not only did real GDP growth slow from an annualised 1.5% quarter-on-quarter (QoQ) in Q1 to 0.7% in Q2, but the contribution of gross capital formation to quarterly GDP growth increased and that of final consumption expenditure decreased (see Chart 2).2
Chart 2. China GDP growth and contributions (% change, QoQ, and % point contribution)
Source: National Bureau of Statistics and EFGAM calculations. Data as at 24 July 2024.
Additional policy support possible
Against this backdrop, there is a compelling case for additional policy support in China, which begs the question as to why such support has not yet been forthcoming. As discussed in a previous Macro Flash Note, China’s conflicting objectives of supporting growth while deleveraging the economy provide a possible explanation.3 Fiscal stimulus has so far been incremental, with Beijing seemingly aiming to do just enough to prevent a more meaningful slowdown in the economy. Given the recent data, it is therefore possible that more stimulus is announced in Q3, though it is once more likely to mark an incremental increase in support rather than anything more meaningful.
In the same vein, monetary policy easing has so far been unsubstantial. The People’s Bank of China (PBoC) did cut its short-term interest rate by 10 basis points on 22 July, but this was the first such move in 2024 and just the third since the start of 2023.4
One possible explanation for the lack of monetary policy easing by the PBoC is renminbi depreciation pressures. In China, authorities calculate a daily central parity rate against the US dollar, often referred to as the fixing rate (see Chart 3). The PBoC then ensures the market exchange rate, known as the spot rate, remains in a 2% range above or below the fixing rate.
Chart 3. Renminbi fixing rate and spot rate vs US dollar
Source: China Foreign Exchange Trade System, LSEG Data & Analytics and EFGAM calculations. Data as at 24 July 2024.
Since mid-2023, the fixing rate has been remarkably stable. This is despite the fact the spot rate has been at the upper bound of the fixing range, making it more costly for the PBoC to prevent renminbi depreciation. The push by the PBoC to halt the renminbi’s depreciation likely reflects President Xi’s desire for a strong currency.5
The PBoC eased monetary policy in July following a US inflation print which resulted in market expectations for interest rates in the US declining. This highlights that officials at China’s central bank are being circumspect about putting the renminbi under further depreciation pressure.6 As such, further monetary policy easing in China will likely depend on economic developments outside of China, particularly those that impact interest rate expectations in the US.
Conclusion
In summary, economic data in China softened in Q2, partially reflecting subdued domestic demand. Despite this, fiscal policy support has been implemented incrementally and it is likely this remains the case given Beijing’s conflicting objectives. Additional monetary policy easing is also possible but will depend more on economic developments outside of China.
From a Chinese equities positioning perspective, Fund Manager Daisy Li noted while the near-term outlook remains challenging, the long-term investment thesis for China still holds promise.
1 Beijing announced trade-in schemes in April which subsidise new household appliances and energy-efficient or new energy vehicles for consumers. CPI inflation for household appliances and vehicles was -1.3% and -5.3% year-on-year respectively in June.
2 In Q1 2024, gross capital formation and final consumption expenditure accounted for 11.8% and 73.3% of QoQ GDP growth respectively. In Q2, gross capital formations share of GDP growth rose to 40.1% and final consumption expenditure’s fell to 46.5%.
3 See previous Macro Flash Note, “China’s Impossible Trilogy” https://www.efginternational.com/insights/2023/chinas_impossible_trilogy.html
4 The People’s Bank of China reduced the 7-day reverse repo rate from 1.8% to 1.7% on 22 July.
5 https://www.reuters.com/breakingviews/strong-yuan-not-stock-market-tops-xis-wish-list-2024-01-23/
6 See previous Macro Flash Note, “Inflation relief – finally” https://www.efginternational.com/uk/insights/2024/inflation_relief_finally.html