China on brink of deflation as prices plunge

China is teetering on the brink of deflation as the world’s second largest economy continues to feel the impact of Beijing’s draconian zero Covid policies.

Consumer price inflation (CPI) fell to zero in the year to June after a sharp fall in pork prices.

The official figure was the weakest reading since February 2021 and below economists’ estimates of a 0.2pc annual rise in CPI.

Factory gate prices are also declining, signalling consumer prices may soon go into reverse. Producer prices fell by 5.4pc in June, marking the ninth straight monthly fall and the steepest drop since the end of 2015.

Analysts at Goldman Sachs said China was likely to slip into deflation – where prices fall instead of rise – as soon as this month.

A temporary period of deflation is good news for households because it raises consumer buying power and helps keep interest rates down.

However, prolonged periods of falling prices can suck economies into a low growth trap where pay stagnates and companies are forced to cut jobs to cope with stagnating demand.

Japan, the world’s third largest economy, has been fighting deflation for decades.

Fears that China may face the same fate hit oil prices. A barrel of Brent crude fell as low as $76.52 in early trading, down by around 1pc.

Deflation is looming in China as the world’s second biggest economy struggles to recover from draconian zero-Covid policies that were only scrapped at the end of last year.

Heightening tensions between Beijing and Washington have also weighed on activity, as Western companies increasingly shift investment away from China.

Youth unemployment in the country stands at 20.8pc and cautious families have been stockpiling cash, rather than spending.

Household deposits have doubled to around £13 trillion (130 trillion renminbi) since the pandemic, with many using their excess cash to pay down their mortgages and other debts, official statistics suggest.

Duncan Wrigley, chief China economist at Pantheon Macroeconomics, said: “Insipid consumer inflation is an indication of the soggy consumer spending recovery, especially for goods, as well as excess production capacity.”

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Several of China’s internet giants reported disappointing sales figures at a major shopping event earlier this month, dashing hopes of a bounce back in demand after Covid restrictions were scrapped.

Low inflation and lacklustre growth means analysts are now sceptical that Beijing will hit its economic growth target of “around 5pc” for 2023. The economy grew by just 3pc in 2022 – one of the weakest rates in the country’s modern history.

Economists expect the People’s Bank of China (PBOC) to respond to the country’s tepid outlook with interest rate cuts to stimulate demand.

Analysts at Barclays said in a client note: “We think the more challenging deflation environment and sharp slowdown in growth momentum support our view that the PBOC has entered a rate-cutting cycle.”

Last month, the central bank trimmed a series of its key interest rates, lowering its one-year loan prime rate (LPR) for the first time in 10 months by 0.1 percentage points to 3.55pc.

The five-year rate, which is closely linked to mortgage deals offered by commercial banks, was trimmed by the same margin to 4.2pc.

LPRs serve as the benchmark for household and business lending rates, suggesting the central bank may take further action in an attempt to boost growth and spending. The one- and five-year rates have not been cut in tandem since August 2022.

Some economists believe Beijing will have to supplement rate cuts with tax reductions or increased spending to boost activity.

However, Mr Wrigley said Beijing was unlikely to be forthcoming with a massive fiscal stimulus.

He said: “So far the public information points towards a targeted, limited stimulus, which will largely be funnelled into support for industry, technology upgrades and private firms, rather than a significant consumer handout.”

Policymakers announced more help for the country’s ailing property sector on Monday to counter heightened fears about unsustainable debt piles.

Companies will be offered loan repayment extensions in order to help cash-strapped developers cope with a downturn in demand.

Looming deflation in China stands in sharp contrast to continued bouts of inflation seen elsewhere in the world.

Britain’s inflation rate stood at 8.7pc in May, forcing the Bank of England to extend its most aggressive round of rate rises in decades.

Unlike many western countries, China did not embark on a massive government spending spree during the pandemic.

While the PBoC trimmed interest rates during lockdowns, it did not engage in a huge money printing exercise. Excess pandemic stimulus has been blamed for fuelling inflation elsewhere in the world.

China’s faltering economic growth threatens to constrain recoveries in other emerging markets, especially Thailand and Hong Kong, which are heavily dependent on Chinese visitors.

Around a million people visited Thailand from China in the first five months after President Xi Jinping finally reopened China’s borders.

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