China’s economy seems to have escaped the threat of consumer-price deflation, at least for the time being. While June and July brought gloomy economic news, the August data, released on Friday, provides some glimmers of hope. However, the housing sector, caught in a prolonged slump, still faces challenges as prices continue to decline in lower-tier cities. Nevertheless, retail sales have picked up, growing by 4.6% compared to just 2.5% in July. Unemployment rates have slightly improved, and recent weeks have seen several measures aimed at boosting lending, including friendlier terms for second-time mortgage borrowers and a significant cut in banks’ reserve-requirement ratios.
These developments reduce the likelihood of a prolonged period of falling consumer prices, which could lead China down a path similar to Japan’s deflationary crisis in the 1990s.
Chinese consumers remain cautious, saving at higher rates than before the pandemic, but there has been some improvement in recent weeks. Notably, job prospects in the service sector, the largest contributor to the economy, seem to be improving. The employment subindex of the services sector purchasing managers’ index, which had plummeted earlier in the year in line with construction employment, is now showing signs of recovery, though it remains below the 50-point mark that separates expansion from contraction. Some high-frequency indicators of consumer activity, such as traffic congestion in major cities, have also begun to rebound.
Furthermore, while headline consumer inflation briefly dipped below zero in July, core inflation, which excludes volatile food and energy prices, reached its highest level since January. The significant drop in pork and fuel prices over the past year, which amplified the decline in the headline inflation index, likely freed up more cash for consumers to spend. Additionally, in August, consumer price inflation for services reached an 18-month high, coinciding with clear signs of stabilization in the services job market.
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The positive news suggests a gradual improvement in the economic situation. However, it’s important to note that this recovery is starting from a very low point, and there are still few reasons to anticipate a robust growth rebound. Instead, the economy may continue to experience a sluggish recovery.
To support economic stability, Beijing must take more steps to stabilize the housing market. Failure to do so could keep consumer confidence low, as falling home prices discourage spending. Moreover, the property sector, which contributes about a quarter of the economy, has the potential to disrupt the job market once again if it remains weak, as seen in the spring and summer.
Even if the property sector begins to stabilize by late 2023, it will still be operating far below 2019 levels. For instance, in August 2023, developers only started building 51 million square meters of new housing, compared to 142 million square meters in August 2019.
As long as this crucial sector of the economy, which also represents a significant portion of household wealth, remains sluggish, it’s challenging to foresee a robust consumer rebound. Policymakers are understandably eager to shift the economy’s focus away from this resource-intensive and wasteful sector. However, for now, there are no viable alternatives to replace it.
