China's Inflation Cools More Than Expected in July

China's Consumer Price Index (CPI) and Producer Price Index (PPI) both registered lower-than-expected increases in July, indicating a significant cooling of inflation. According to data released by the National Bureau of Statistics (NBS), annual consumer inflation eased to 0.5%, its slowest pace since January, while factory-gate prices rose by 3.5% year-on-year, marking the weakest increase in three months. This slowdown underscores the uneven nature of the country's economic recovery and the ongoing deflationary pressures.

The July CPI figure fell below the 0.8% forecast by a Bloomberg survey and broader market expectations. It marked a notable deceleration from the 1% annual increase recorded in the previous month. Core CPI, which excludes volatile food and energy prices, increased by 0.9% year-on-year. Food prices, specifically, declined by 1.5% year-on-year, with pork prices continuing their downward trend. On a month-on-month basis, CPI edged down by 0.1%.

The 3.5% year-on-year increase in PPI also fell short of June's 4.1% rise and economists' expectations of 3.8%. Key factors contributing to this moderation included sluggish domestic demand, a retreat in global energy/oil costs, and adverse weather conditions such as high temperatures, heavy rainfall, and typhoons that slowed construction activity. On a month-on-month basis, PPI decreased by 0.7%.

These inflation figures reinforce the narrative of a two-speed Chinese economy, characterized by robust factory output and exports, boosted by increasing overseas demand for AI-related technology products, contrasted with persistent weakness in domestic consumption. Indicators pointing to a softening economic momentum in the second quarter of 2026 underpin these price pressures. The ongoing slump in household spending and the property market, in particular, exacerbate the risk of sustained deflationary trends.

The decline in global energy prices, partly due to an easing of the oil shock from the US-Iran war, has somewhat alleviated cost pressures on manufacturers. However, profit margins remain under pressure for many manufacturers, especially those exposed to elevated input costs and limited pricing power in certain sectors. A divergence in profits is observed between upstream and downstream sectors, with energy producers experiencing rising profits while industries like apparel manufacturing face declining earnings.

In response to these economic headwinds, the ruling Communist Party's Politburo signaled at its late July meeting that it would accelerate fiscal spending on already budgeted infrastructure projects to bolster growth and stimulate domestic demand by year-end. Analysts anticipate that the transmission of fiscal stimulus will be felt with a lag of approximately one quarter. Some economists caution that a return to healthy inflation may take time, and persistent deflationary pressures could harm long-term growth if not addressed by boosting household spending. Therefore, structural reforms aimed at increasing household income and social security benefits are highlighted as crucial for the period ahead.