Policymakers continued incremental approach to easing partly reflects a desire to reserve policy space in case a Trump presidency sparks another trade war.

The 2024 growth target of “around 5%” remains on a knife edge, and despite signs that past policy easing is gaining traction, further supportive measures will be needed to shore up growth and stop ‘low-flation’ from becoming ingrained.

Our Chinese Financial Conditions Index (CFCI) has at least eased for the third consecutive month, moving into a marginally more accommodative stance (Chart 1).

Money & Credit remains a drag on the CFCI largely due to weakness in money growth – especially M1.

A negative credit impulse is also not helping, but July may have marked the low point, and it now appears to be turning back up. Robust government debt issuance of RMB 1.6 trillion in August helped underpin credit expansion during the month. Issuance should remain strong for the remainder of the year, which could help push the CFCI modestly higher.

Incremental easing remains the preferred approach

Further easing measures are expected, but they are unlikely enough to turn around depressed household confidence or market sentiment.

Speculation is rife that banks will be pushed to lower interest rates on existing mortgages, potentially by as much as 80 bps. Households may also be able to refinance mortgages at lower rates by switching providers. Such steps would provide a welcome boost to disposable income and may help sentiment to recover over time (Chart 2).

Questions remain about the People’s Bank of China’s (PBOC) willingness to push through mortgage changes and lower rates more generally. The PBOC has voiced concern about the squeeze on banks’ net interest margins while announcing that banks will be stress-tested regarding their exposure to a back-up in yields.

However, focusing on financial stability risks addressing the symptoms rather than the root causes. Indeed, the private sector's demand for borrowing funds appears to have stepped down a gear since Q1: corporate and household borrowing has declined by RMB 0.3 trillion (Chart 3).

It is perhaps unsurprising that weak demand for funds, high household savings, and a tepid nominal environment continue to push long-dated yields down despite the PBOC’s efforts to intervene via a ‘reverse operation twist’ (Chart 4).

Activity remains underwhelming

China’s August data releases generally reinforced the lackluster economic picture that emerged over the summer: many headline activity measures slowed and fell short of consensus expectations, while most housing metrics continue to slide.

Industrial production slowed to 4.5% year over year (y/y), down from 5.1% in July and below expectations of 4.7%. Retail sales expanded just 2.1% y/y (-0.6 ppts), while the services output index eased to 4.6% (-0.2 ppts).

Fixed asset investment was only 0.1 ppt below consensus at 3.4%, but the miss is exacerbated by the fact that this is a year-to-date metric, which should be less volatile.

There is always a risk that year-over-year growth rates are slow to pick up changing economic momentum. Our month-over-month China Activity Indicator (CAI) has firmed slightly over the past two months, helped by an improving export sector (Chart 5).

It still appears that Q3 GDP growth will be soft, leaving the authorities’ “around 5%” growth target on a knife edge.

Even if our CAI has shown some sequential improvement, it is questionable that momentum can recover more conclusively. At the same time, there is little sign that the housing market is finding a firmer foundation.

Most key housing metrics continued to slide in August (Chart 6). New starts haven’t been this weak since 2005, while prices continue to fall rapidly.

Is China sleepwalking into Japanification?¹

A painful real estate adjustment is one potential parallel with Japan’s slide into its lost decade. At least superficially, China faces similar challenges across several other key dimensions, including its rapidly aging population, high national savings, export-led growth model and trade tensions, becoming a major auto manufacturer, complex relationship between banks and corporates, policy that favors incremental easing, and, finally, policymakers who put other priorities above an inflation target.

China’s still relatively low stage of development is a key bulwark against Japanification. Even if price growth remains tepid, nominal GDP should remain high enough to guard against adverse debt dynamics and ‘balance sheet’ recession risk.

But even if fears of Japanification are overstated, questions remain as to whether China is sleepwalking into ‘low-flation’.¹

Headline CPI inflation was positive for the seventh month in August, but it is still advancing at a tepid pace of only 0.6%. Recent dynamics in producer prices imply that consumer goods inflation in the CPI basket is likely to be short-lived (Chart 7).

¹ Japanification refers to the stagnation that Japan’s economy has faced over the past three decades and is typically applied in reference to the concern among economists that other developed countries will follow along the same path.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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