China’s recovery stalls as K-shaped divergence widens
The desk believes that China's economic challenges are intensifying, particularly as evidenced by the widening K-shaped recovery divergence noted in recent research. Per the full note, domestic demand remains weak, with retail sales and investment hitting post-pandemic lows despite a boost in exports, which grew 18.5% year-on-year in the first seven months. These dynamics, coupled with incremental stimulus measures lacking the necessary heft, signal sustained weakness ahead for the Chinese economy, which has implications for broader FX sentiment towards the yuan and related currency pairs.
What the desk is arguing
The desk frames this as an indication that China’s recovery is faltering, with both domestic demand and property sectors underperforming. Specifically, recent data shows that retail sales and fixed asset investment have dropped to their lowest levels since the pandemic. Additionally, policy measures from the Chinese leadership, while supportive, are described as cautious, focusing on existing approved funds rather than new initiatives, which limits immediate market optimism.
Evidence from the recent July Politburo meeting supports this sentiment, as minimal new fiscal stimulus was announced, pointing to a preference for incremental adjustments rather than sweeping reforms. For instance, though exports continue to surge, the underlying weakness in domestic consumption and investment poses risks that could exacerbate volatility in China-related markets.
Where it sits in our coverage
Our consensus target for USD/CNY sits at 1.075, supported by an aligned view from jpmorgan, targeting 1.10 by March 2026. In contrast, bofa presents a bearish stance, projecting a lower target of 1.04 in the same timeframe.
Given the divergence, our view is at the center of this spreading forecast range, suggesting a cautious watch on any developments that may push the situation either towards recovery or deeper into declines in the upcoming months.
How other firms see it
Firms like jpmorgan and others are aligned with our bearish outlook on the yuan, reflecting concerns regarding China's stagnant domestic growth. On the other hand, firms such as bofa take a more pessimistic stance, expecting significant downside potential.
With China’s recovery faltering, keep an eye on cross-currency flows, particularly in how they may reflect on USD/CNY. Similarly, the trajectory of the yuan affects broader Asian currencies and could influence trade flows.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01China's economic recovery is showing signs of stagnation, particularly in domestic demand sectors.
- 02Exports have increased substantially yet the domestic side falters, widens concerns over K-shaped divergence.
- 03Incremental policy support from the government may be insufficient amid ongoing contraction in key sectors.
- 04The current forecast spread indicates divided views among major financial institutions on the yuan's future.
Market implications
Watch for the USD/CNY pair's response to ongoing trade data and further domestic policy announcements. Levels to monitor include 1.075 as a potential pivot point, with upcoming release schedules likely to add further volatility.
Risks to this view
A stronger-than-expected rebound in domestic consumer sentiment or substantial fiscal stimulus could invalidate the current bearish outlook on the yuan, leading to a potential shift in sentiment and bullish pressure on the currency.
Articles China’s recovery stalls as K-shaped divergence widens Published 11:36 China Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download China got off to a sluggish start in the second half of the year, with the economy’s K‑shaped divergence still widening, and policymakers signalling that stimulus will likely be incremental and targeted Lynn Song Recent economic indicators point to renewed weakness in China China’s K-shaped divergence continues to widen China’s data has deteriorated again in recent weeks, underscoring that the slowdown hasn’t bottomed as the third quarter gets underway. China’s K‑shaped divergence is widening this year. External demand remains a strong leg, with exports up 18.5% year‑on‑year in the first seven months thanks to surging shipments of cars, ships, and chips.
And despite an even bigger jump in imports, net exports have swung back into positive territory – a sign that trade is doing more heavy lifting as domestic momentum softens. But domestic demand indicators once again missed forecasts across the board. Retail sales and fixed asset investment both slumped to post-pandemic lows, while the property sector and credit data continue to contract sharply year-on-year.
Modest policy support expected ahead China’s July Politburo meeting drew intense scrutiny for signs of fresh stimulus. The tone was upbeat enough, but the substance underwhelmed: leaders offered little in the way of new support and instead signalled a preference for incremental and targeted easing through existing tools. On the fiscal front, the priority will be accelerating the use of already‑approved funds, not rolling out new quotas.
Bond issuance is expected to accelerate in the coming months to finish using this year's existing quotas. The government announced a set of policy measures to support domestic demand at the start of August, centred on broadening the scope of interest subsidies for consumer loans. The loan ceilings were also raised.
The next few months of data will show whether the policy shift is gaining traction, but we expect any boost to be modest at best. More help does appear to be coming. On 21 August, the Ministry of Finance signalled that additional fiscal measures are in the pipeline, with more spending aimed at households and consumption, and tighter coordination across fiscal, monetary, and industrial policy to amplify the impact.
We still see a solid case for a 10bp rate cut before year‑end, especially with inflation and growth momentum both fading and credit demand still soft. Lowering growth and inflation calls as momentum stalls Given the soft start to the second half and signs that policy support will remain relatively modest, we’re trimming our 2026 GDP forecast slightly – to 4.6% YoY from 4.7%. On the inflation side, we see persistent drags from food and rent, which are denting the reflation theme.
Price competition for the economy as a whole remains significant despite "anti-involution" efforts in select industries. Higher energy prices and broadly steady core inflation should keep headline inflation comfortably positive this year, but we’re trimming our full‑year forecast to 0.9% YoY from 1.2%. We’re keeping our 6.67–6.92 USDCNY fluctuation band for the yuan in the second half of 2026.
But risks are increasingly skewed toward CNY strength. Appreciation expectations remain firm, and China’s current-account surplus and pent-up buying pressure from Chinese exports continue to support the CNY. Monetary Policy Inflation GDP China Asia Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives.
The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author Lynn Song Chief Economist, Greater China Lynn Song joined ING in January 2024 as the Chief Economist for Greater China. Prior to joining ING, he worked at China Construction Bank International, China Merchants Securities (HK), and Haitong… In this article China’s K-shaped divergence continues to widen Modest policy support expected ahead Lowering growth and inflation calls as momentum stalls
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