China’s reflation trend continues to solidify
The current landscape suggests persistent inflationary pressures in China are leading to a more stable reflation environment. As reported, China's consumer price index (CPI) held at 1.2% year-on-year while the producer price index (PPI) climbed to 3.9%, indicating an ongoing transition away from deflation. Per the full note source, this shift may have meaningful implications for global risk assets and currency positioning, particularly as traders assess the impact of these inflation trends on the People's Bank of China's policy stance in the near term.
What the desk is arguing
The desk argues that China's inflation data signals a solidifying reflation trend amid stable prices for consumer goods. The latest figures show CPI at 1.2%, unchanged from prior months, while PPI shows an upward trajectory at 3.9%, pointing to increased costs in the manufacturing sector. This consistent inflation reading, as noted by ING in their analysis, underlines a transition from deflation toward an environment of low inflation, which could have substantial repercussions for currency movements.
Specifically, the CPI’s steady performance alongside rising energy prices, particularly transportation fuels that have increased by 21.1% year-on-year, reflects an underlying strength in consumer demand despite deflationary pressures in food and housing costs. This duality suggests that while certain categories are suppressing inflation, broader market trends indicate a potential lift-off from disinflationary conditions in the near future.
In rejecting a less optimistic alternative view, the desk highlights that the prevailing modest inflation should not be interpreted as a stagnation of economic recovery but rather a characteristic feature of the current transition phase, enhancing expectations of gradual normalization in consumer pricing.
Where it sits in our coverage
Our consensus target for USD/CNY sits at 1.075, with a range from 1.04 to 1.12 as per our internal analysis. Notably, JPMorgan has set a Mar-26 target at 1.10 while BofA stands contrary with a target of 1.04 over the same tenor.
This desk’s forecast aligns closely with JPMorgan's outlook at the higher end of the consensus range, reflecting a belief that the ongoing inflationary data will necessitate a strategic response from policy makers that could further bolster the yuan against the dollar going forward.
How other firms see it
Several firms, including Goldman Sachs and DBS, share an aligned view, suggesting that continued reflation in China could provide a catalyst for yuan appreciation. Conversely, BofA maintains a bearish outlook, citing potential risks stemming from global tightening policies.
The anticipated currency movements are intricately linked with CPI dynamics, particularly as the yuan's trajectory against the USD may mirror the broader implications for emerging markets. Traders should keep an eye on potential spillover into additional pairs such as AUD/USD, given its sensitivity to China's economic signals.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01China's CPI remains steady at 1.2% YoY amid increasing PPI at 3.9%.
- 02The reflation trend indicates a shift away from deflation towards low inflation.
- 03Persistent food prices and negative housing inflation are key factors in current dynamics.
- 04Related currency pairs, including AUD/USD, may reflect shifts in market sentiment tied to China's inflation outlook.
Market implications
Moving forward, traders should closely monitor CPI reports and any potential policy announcements from the People's Bank of China, particularly with expectations of a more pronounced inflation trend. A notable resistance level to watch will be around 1.075 for USD/CNY as the market navigates these developments.
Risks to this view
Potential catalysts that could invalidate this outlook include a sudden pivot by the People's Bank of China towards aggressive monetary tightening or a significant deterioration in global economic conditions that dampens demand for Chinese exports, which may renew deflationary forces in the economy.
Older quick take Quick take 04:29 China China’s reflation trend continues to solidify China’s May inflation data was broadly in line with forecasts, with CPI steady at 1.2% year-on-year and PPI rising to 3.9%. Food and property prices are helping suppress headline inflation for now. But rising prices more broadly suggest we're moving from deflation into a low inflation environment Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Lynn Song Chief Economist, Greater China 3.9% YoY China's May PPI inflation CPI inflation steady in May as higher energy is offset by slumping food and rental prices China's CPI inflation remained unchanged at 1.2% year-on-year in May, marginally softer than our forecast and market expectations for a slight uptick to 1.3%.
Inflation has been at or over 1% for the past 4 months, and in positive territory for 8 straight months, suggesting the reflation trend is solidifying. Consumer prices were supported by a major surge in the transportation fuels subcategory, which rose 21.1% YoY in May, reflecting higher oil prices. While local gasoline prices generally didn’t rise as much as Brent crude oil, we saw moves of around 24% above pre-Iran War levels.
If crude oil prices remain elevated for longer, pump prices could rise further. Most inflation subcategories were fairly stable in May. Clothing (1.4%), healthcare (2.1%), and Education, Culture, and Entertainment (1.3%) were all within 0.1pp of April's data.
Two main categories continue to hold back inflation: First, food inflation fell further to -1.7% YoY in May, as pork (-16.1%), fresh fruit (-2.2%), dairy (-1.2%), and edible oil (-1.2%) remained in deflationary territory. China's pork cycle has taken longer than normal to turn. This has been attributed to rising production efficiency, while purchase agreements to import soybeans could also be contributing to low feed prices.
Second, housing inflation remained negative for a sixth consecutive month. Rental prices fell -0.6% YoY, as the property market has yet to confirm a bottom. We've seen some positive signals in the recent monthly property price data.
They include stabilisation in tier-1 cities and an overall slower pace of price declines. This drag, though, is likely to continue in the near term. These factors will likely keep China's CPI inflation at positive but low levels moving forward.
Falling food and rental prices are balancing out higher inflation elsewhere Higher energy having clearer upward impact on PPI inflation PPI inflation rose to 3.9% YoY, up from 2.8% in April and in line with expectations. However, in month-on-month terms, producer prices actually cooled from 1.7% to 0.5%, a 3-month low. Looking at ex-factory prices, we see the biggest increases in non-ferrous metals mining (36.5%) and oil and gas extraction (35.7%) industries.
The petroleum and coal processing industries also saw prices rise by 18.4% YoY in May. The trend in the non-ferrous metals industry was already underway before the Iran war. But upticks in the oil and gas extraction and fuel processing industries clearly reflect the impact of higher energy prices.
The Iran war has accelerated what was previously set to be a more moderate return to positive PPI inflation. Raw material prices further accelerated to 9.2% YoY, and look set to move into the double-digits in the coming months. This is likely to feed through to other prices in the coming months.
Many producers operating on thin margins will have no choice but to pass on the cost to consumers. Rising raw material costs are likely to feed through to other prices moving forward Will China see second-round inflation effects? In the past few months, you may have seen some of my colleagues write about so-called second-round effects on inflation.
This is where the impact of higher wages in response to initial price upticks leads to workers demanding higher wages, companies raising prices to stay profitable, and a wage-price spiral. Is this going to happen in China? If so, it could actually be welcome news for many workers, after deflationary expectations and general cost-cutting pressures amid involution-type competition led to years of slowing wage growth and even pay cuts.
We're not expecting major momentum on this front this year. This is especially the case as we still see elevated youth unemployment numbers, and many workers are more concerned about keeping their jobs amid AI advancements. Anecdotal observations suggest that many workers' bargaining power and mobility still seem generally weaker than in the pre-COVID era.
With that said, if it does play out, it marks an upside risk for our inflation forecast of 1.3% YoY. For now, though, this sort of low but positive inflation isn't likely to impede potential monetary policy easing. This is still on the table this year, especially if we see economic data continue to soften.
Could recent reflation turn around the falling wage growth story? Monetary Policy Inflation Emerging markets China Asia Pacific 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.
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