China Consumer Prices Fall for First Time in Two and a Half Years... Deflation Fears Spread

China's consumer price inflation rate in July fell for the first time in 2 years and 5 months. As domestic consumer sentiment cools, fears of deflation are intensifying.

According to the National Bureau of Statistics of China on the 9th, China's Consumer Price Index (CPI) in July decreased by 0.3% year-on-year. The CPI inflation rate slowed from 2.0% in January this year to 0% in June, and last month showed a negative growth rate for the first time in 2 years and 5 months since February 2021.

Last month, the Producer Price Index (PPI) also fell by 4.4% compared to a year earlier, continuing its negative streak for 10 consecutive months. As a result, China's monthly CPI and PPI both recorded negative growth simultaneously for the first time in 2 years and 8 months since November 2020.

With the CPI inflation rate declining, there are increasing assessments that the Chinese economy has effectively entered a deflationary phase. Deflation, where prices steadily fall, leads to far more severe consequences than inflation. When product prices continue to drop, consumers postpone spending and economic activity contracts. Inventories accumulate, and companies reduce investment and jobs, creating a vicious cycle. In a deflationary situation, government stimulus measures have diminished effectiveness. As the real estate market stagnates long-term, exports decline, and the domestic market weakens, fears of deflation in China are becoming a reality, raising concerns that China could experience a Japan-style prolonged recession that lasted for decades.

The Chinese government immediately moved to contain the situation. The National Bureau of Statistics explained that the CPI decline is due to a base effect from last year's sharp rise and that a gradual rebound is highly likely. The government’s position is that there is no basis to believe prices will fall long-term, and the CPI inflation rate is expected to approach 1% by the end of the year. Meanwhile, the government has even issued guidelines to private investment institutions to refrain from discussing deflation, stepping up controls.

However, the market has accepted China's entry into a deflationary phase as a given and advises the implementation of large-scale economic stimulus measures.

Robin Singh, Chief China Economist at Morgan Stanley, said in an interview with Bloomberg TV, "China is definitely in a deflationary state. The question is how long it will last. It depends on how policymakers respond through coordinated fiscal and monetary easing policies." He added, "All government spending should be increased," emphasizing, "It is necessary to expand government expenditure and ensure cooperation between monetary and fiscal easing policies."