June’s factory gate price turned flat and the lowest reported since August 2016 while headline consumer price (CPI) rose at the same pace as in May by 2.7%y/y. Looking at the headline CPI, apart from food inflation, inflation is actually soft. It may have peaked and starting to cool off as we move into 2H2019. However, there is little risk of it turning into deflation. In our view, the deflationary risk is more on the PPI.

The latest factory gate figure raises that concern. Factory gate price provides a good gauge on how industrial demand behaves and shows the momentum to investment and profits. Hence, there are growing possibilities for the Chinese authorities to embark on a more aggressive stimulus but unlikely to resort to large-scale fiscal stimulus. We foresee more “off-balance sheet” fiscal support to come into the picture to support growth and implement financing tools like reserve requirement ratio (RRR) cuts to support small and private firms. We see room for two 50bps cuts in the RRR to take place in 3Q and 4Q.

• Producer prices (PPI) in June turned flat after reporting a 0.6% y/y growth in May. June’s factory gate price was the lowest reported since August 2016 and fell short of consensus’ 0.3%. The flat factory gate price was due to lower oil prices and weak global demand. Also, tariffs and weaker domestic demand hit new orders for goods.

• Meanwhile, headline consumer price (CPI) rose at the same pace as in May by 2.7% y/y in June, falling in line with consensus. It was driven by higher food prices reflected by the surge in fruit prices (+42.7% y/y) and pork (+21.1% y/y). Supply shortages triggered by the African swine fever outbreak and extreme weather conditions continued to push up pork and fruit prices.

• Looking at the headline CPI, apart from food inflation, inflation is actually soft. It may have peaked and starting to cool off as we move into 2H2019. However, there is little risk of it turning into deflation. In our view, the deflationary risk is more on the PPI. The latest factory gate figure raises that concern. Factory gate price provides a good gauge on how industrial demand behaves and shows the momentum to investment and profits.

• Although the US and China has reached another ceasefire in their trade war last month, we expect continuing pressure on the Chinese economy as manufacturers shift more production abroad to avoid US tariffs on China-made goods.

• Hence, there are growing possibilities for the Chinese authorities to embark on a more aggressive stimulus. While fiscal stimulus measures remain, Beijing is unlikely to resort to large-scale stimulus. We foresee more “off-balance sheet” fiscal support to come into the picture to support growth. At the same time, we can expect China to implement financing tools like reserve requirement ratio (RRR) cuts to support small and private firms. We see room for two 50bps cut in RRR to take place in 3Q and 4Q.

Source: AmInvest Research - 11 Jul 2019