China's Inflation Cools in July Below Expectations as Oil Shock Eases

China's factory-gate inflation eased more than expected in July, while consumer prices also decelerated, according to data released by the National Bureau of Statistics. This development signals that cost pressures from the oil shock in global energy markets, which emerged after the Iran war began in late February, are starting to fade.

In July, the Producer Price Index (PPI) increased by 3.5% year-on-year, following a 4.1% rise in the previous month, falling short of economists' forecasts of a 3.8% increase in a Reuters poll. This marked the weakest annual increase in three months. Meanwhile, the Consumer Price Index (CPI) decelerated to 0.5% year-on-year from June's 1.0% gain, missing market expectations of a 0.8% rise and reaching its lowest level since January. On a monthly basis, CPI fell by 0.1%, defying expectations for a 0.2% increase, indicating that receding energy prices and soft domestic demand contributed to reduced inflationary pressures.

The retreat in global energy prices, despite the ongoing U.S.-Iran war, played a key role in this deceleration. Lower commodity costs eased price pressures for some manufacturers, though challenges persist for companies still exposed to elevated input expenses and sluggish domestic demand. China's economy continues to show an uneven recovery, with robust factory output and exports contrasting with weaker household spending and domestic demand. This suggests a softening of overall economic momentum during the second quarter.

The war in Iran, which began in February 2026, led to one of the largest supply disruptions in the history of the global oil market due to the closure of the Strait of Hormuz, causing oil prices to double from pre-war levels at one point. The International Monetary Fund (IMF) had previously stated that every 10% increase in oil prices would push global inflation up by 0.4 percentage points and reduce worldwide economic output by as much as 0.2%. Policymakers in Beijing are grappling with a prolonged downturn in the property market and fierce competition within some industries, attempting to revive consumer confidence and spur spending through various measures.

Zhiwei Zhang, chief economist at Pinpoint Asset Management, noted that the weakening in consumer and producer inflation was consistent with other economic indicators, such as a larger-than-expected decline in China's purchasing managers' index. The Politburo's signal in July to accelerate fiscal spending on budgeted infrastructure projects indicates efforts to bolster growth. However, the transmission of fiscal spending into the economy is expected to take time. This suggests that China may require further policy support to achieve a balanced recovery as it grapples with deflationary pressures.