China Faces Policy Challenges as Consumer Inflation Slows and Deflation Deepens

Data released on Thursday revealed that China experienced its slowest increase in consumer prices in over two years in April, while deflation in the factory sector intensified. These indicators suggest that further stimulus measures may be necessary to bolster the country’s uneven post-COVID economic recovery.

The modest rise in consumer prices underscores the lackluster domestic demand, as indicated by this week’s trade data. Simultaneously, the persistent deflationary trend in producer prices highlights the challenges faced by factories, creating a dual challenge for the world’s second-largest economy as it strives to overcome the impact of the pandemic.

According to the National Bureau of Statistics (NBS), the consumer price index (CPI) in April recorded a year-on-year increase of 0.1%, marking the lowest rate since February 2021 and a decline from the 0.7% growth observed in March. This figure fell short of the median estimate of a 0.4% rise in a Reuters poll.

Furthermore, producer deflation deepened last month, exacerbating the broader struggles of the economy following the easing of COVID restrictions in December. The producer price index (PPI) experienced its sharpest decline since May 2020, falling by 3.6% year-on-year for the seventh consecutive month, compared to a 2.5% drop in the previous month. This figure deviated from the forecasted 3.2% decline.

Although China’s economy outpaced expectations in the first quarter due to the lifting of COVID restrictions, the recovery has been uneven. Recent data indicates a contraction in factory activity, while the persistent weakness in the property market remains a concern.

According to analysts, the reopening of the economy has likely contributed to an increase in services inflation, although this effect has been partly offset by a slowdown in the growth of food and energy prices.

The latest data could potentially increase the pressure on the People’s Bank of China (PBOC) to consider rate cuts or inject more liquidity into the financial system. In March, the PBOC already implemented its first reduction in lenders’ reserve requirements ratio (RRR) this year.

In addition to the reserve requirement adjustment, China has instructed its banks to lower the maximum interest rates they offer on certain types of deposits.

Given the weakening post-COVID recovery, ongoing disinflation, declining market rates, and signals from the Federal Reserve indicating a potential pause in their policy, there is a growing belief among experts, such as Ting Lu, Chief China Economist at Nomura, that a PBOC policy lending rate cut is becoming increasingly likely.

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