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China may dodge deflation, after all

Chinese consumers remain very cautious and still appear to be saving at much higher levels than before the pandemic. But things have clearly improved somewhat in recent weeks. (Photo: Bloomberg)
Chinese consumers remain very cautious and still appear to be saving at much higher levels than before the pandemic. But things have clearly improved somewhat in recent weeks. (Photo: Bloomberg)

Summary

But it will probably be a near miss, and economic data still hints at a bottom rather than a strong rebound.

China’s economy appears to have survived its near miss with a damaging bout of consumer-price deflation—for now.

After a grim June and July, China’s main August economic data, released Friday, contained clear hints of improvement. The news from the critical housing sector, which is mired in a protracted slump, was less encouraging: Price falls accelerated in lower-tier cities. But growth in retail sales accelerated to 4.6% from a year earlier, from just 2.5% in July. Unemployment ticked down marginally. And the past few weeks have witnessed a flurry of measures to support lending: Easier terms for second-time mortgage borrowers, and a big cut to banks’ reserve-requirement ratios on Thursday.

All of this makes a protracted fall in consumer prices—which could trap China in a 1990s Japan-like cycle of falling prices and ultra-thrifty consumers—less likely.

Chinese consumers remain very cautious and still appear to be saving at much higher levels than before the pandemic. But things have clearly improved somewhat in recent weeks.

Most notably, job seekers in services—the economy’s biggest sector—seem to be having better luck. The services sector purchasing managers employment subindex, which plummeted in line with construction employment this spring, has now begun rising again—although it remains below the 50 point mark separating expansion from contraction. Some high frequency measures of consumer activity, including traffic congestion in major cities, also started to rebound in the late summer, according to Goldman Sachs.

Moreover, even as China’s headline consumer inflation dipped briefly below zero in July, so-called core inflation—excluding volatile food and energy prices—had actually risen to its highest point since January. The large fall in pork and fuel prices over the past year, which magnified the drop in the headline index, probably also freed up more cash for consumers to spend on other things. And in August, consumer price inflation for services hit an 18-month high—at the same time the job market in services, at least, was beginning to show clear signs of bottoming out.

So the good news is that things are looking up, on the margins. The bad news is that this is all starting from a very low base—and there are still few reasons to expect a strong growth rebound, rather than a weak muddling through.

Beijing needs to do more to put a floor under the housing market. If it doesn’t, falling prices will keep weighing on households’ inclination to spend. And weakness in the property sector—which accounts for about a quarter of the economy—could undermine the entire job market again later in the year, like it did this spring and summer.

Even assuming the property sector finally begins to bottom out in late 2023, activity remains way below 2019 levels. Developers started building just 51 million square meters of new housing this August, according to figures from data provider CEIC. In August 2019, they started building 142 million square meters.

As long as such an important chunk of the economy—and the key store of household wealth—remains flat on its back, it is hard to envision a strong consumer rebound, and the job market will remain at risk. Policy makers are understandably eager to reorient the economy away from a sector that has consumed so many resources and produced so much waste.

But for now, at least, there simply isn’t anything else that can replace it.

Write to Nathaniel Taplin at nathaniel.taplin@wsj.com

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