China is on the brink of deflation with prices plummeting

China’s economy is on the verge of deflation, as the world’s second-largest economy continues feeling the impact of Beijing’s draconian zero Covid policy.

After a steep fall in pork prices, the Consumer Price Index (CPI) dropped to zero for the entire year ending June.

The official reading was the lowest since February 2021, and well below economists’ expectations of a CPI rise of 0.2pc annually.

The factory gate prices have also fallen, indicating that consumer prices could soon reverse. In June, producer prices dropped by 5.4pc. This is the ninth consecutive monthly drop and the largest since 2015.

Goldman Sachs analysts said China could slip into deflation, where prices drop instead of rising, as early as this month.

Deflation, even if temporary, is a good thing for consumers because it increases their purchasing power and keeps interest rates low.

The prolonged period of falling prices, however, can trap economies in a low-growth trap. Pay stagnates while companies have to reduce their workforce due to stagnant demand.

Japan, the third largest economy in the world, has been fighting against deflation since decades.

Oil prices fell as a result of fears that China could suffer the same fate. Early trading saw a barrel of Brent crude fall to $76.52, a drop of around 1pc.

China is facing deflation as it struggles to recover after the draconian Zero-Covid policy that was only abandoned at the end last year.

The increasing tensions between Beijing, Washington and other Western countries have also affected the activity of Western companies as they increasingly move their investment away from China.

The youth unemployment rate in the country is 20.8pc, and families are stockpiling money rather than spending it.

Official statistics show that household deposits have increased by around £13 trillion (130 billion renminbi), with many people using the extra cash to pay off their mortgages and debts.

Duncan Wrigley is the chief China economist for Pantheon Macroeconomics. He said that “insipid consumer prices are an indicator of the soggy recovery in consumer spending, particularly on goods, and excess production capacity.”

A major shopping event in China earlier this month saw disappointing sales numbers from several of China’s Internet giants, squelching hopes for a rebound in demand following the removal of Covid restrictions.

Analysts are sceptical about Beijing’s ability to achieve its “around 5pc growth” target for 2023 due to low inflation and a lackluster growth. In 2022, the economy grew at a rate of just 3pc – the lowest in modern Chinese history.

Economists anticipate that the People’s Bank of China will respond to China’s tepid economic outlook by reducing interest rates to stimulate the demand.

Barclays analysts said in a note to clients: “We believe the more challenging deflationary environment and sharp decline in growth momentum supports our view that the PBOC is entering a rate-cutting phase.”

The central bank cut a number of key interest rates last month. It lowered its prime loan rate (LPR), which is the one-year loan rate, for the first 10 months, by 0.1 percent points, to 3.55 percent.

The rate for five years, which is closely tied to the mortgage deals offered by banks commercial, has been lowered by the same margin, to 4.2pc.

The LPRs are used as a benchmark for lending rates to households and businesses, which suggests that the central bank could take additional action in order to boost spending and growth. Since August 2022, the one- and five year rates haven’t been reduced in tandem.

Some economists think Beijing will need to combine rate reductions with tax cuts or increased spending in order to stimulate activity.

Wrigley, however, said Beijing would be unlikely to provide a massive fiscal stimulant.

He said: “So Far, the public information indicates a targeted, small stimulus which will be largely funneled into support for industry and technology upgrades, as well as private firms. It is not a large consumer handout.”

On Monday, policymakers announced additional help for the country’s struggling property sector to counter increased fears about unsustainable loan piles.

To help developers who are cash-strapped cope with the downturn in demand, companies will offer loan repayment extension.

The looming deflation of China is in stark contrast to the continued inflation elsewhere in world.

Britain’s inflation rate was 8.7pc at the end of May. This forced the Bank of England’s most aggressive rate hikes in decades.

China, unlike many western countries did not go on a spending spree to pay for the pandemic.

The PBoC did reduce interest rates in lockdowns but it didn’t engage in a massive money printing exercise. The excess pandemic stimulus is blamed for fueling inflation in other parts of the world.

China’s slowing economic growth could hinder the recovery of other emerging markets. This is especially true for Thailand and Hong Kong which heavily depend on Chinese tourists.

In the first five month after President Xi Jinping reopened China’s borders, around a million Chinese tourists visited Thailand.