China’s Deflation Is Over. Its Demand Slump Is Not.

The end of factory-gate deflation

For much of the past year, China’s problem was prices that were too low. Producer prices fell 2.1% in October 2025, 1.9% in December and as recently as February they were still 0.9% lower than a year earlier. In August 2026 they were 3.8% higher. Consumer prices rose 0.8%, and core prices, which leave out food and energy, rose 1.0%.

The National Bureau of Statistics gave an unusually direct explanation. Higher international crude oil and non-ferrous metal prices pushed up costs in domestic industries, it said, lifting prices in oil extraction, refined products and organic chemicals. Domestic gasoline rose 9.3% over the year, and coal mining prices were 26.6% higher. In other words, the conflict in the Middle East has pushed factory-gate prices back into positive territory.

The price swing

Consumer and producer prices, year-on-year change, selected months.

Imported inflation, not domestic demand

The distinction matters. When prices rise because households are spending more, central banks are reassured. When they rise because oil is dearer, as here, the effect tends to squeeze demand rather than strengthen it. Consumer prices are still only 0.8% higher, and food, tobacco, liquor and dining out were 0.7% cheaper than a year earlier. Pork, a staple of the Chinese price index, was 11.8% cheaper in August according to one report of the data. The pressure is concentrated in the parts of the economy that import energy and metals.

Seen from Beijing, this is a mixed blessing. Factory margins improve when output prices rise, and industrial profits rose 16% in the first eight months. But when the price rise is imported, the gain accrues to oil producers abroad, and the real income of Chinese households does not rise to match.

Two economies in one

The activity data for August show the split. Industrial output rose 5.2% over the year, faster than July’s 4.5% and above forecasts of about 4.8%. Retail sales, by contrast, grew only 0.4%, slower than 0.6% in July. Fixed-asset investment fell 7.2% in the first eight months, worsening from 6.7% in the first seven. New home prices fell 0.1% in the month and are 3.0% lower than a year ago.

The result is that second-quarter growth slowed to 4.3% from 5.0% in the first quarter, against an official 2026 target of 4.5% to 5%, the lowest since 1991. Within consumption, services are holding up better than goods: retail sales of services were 5% higher in the first seven months, against 1.1% for goods.

Two economies in one

Year-on-year change, latest data.

4Exports carry the load

With the home market weak, exports are doing much of the work. Chinese exports rose almost 24% in July from a year earlier and more than 18% in the first seven months, according to AP, supported by demand for high-tech goods such as semiconductors during the artificial intelligence boom. Demand for electric vehicles has also been lifted by higher energy costs because of the Iran war. Economists quoted by AP believe China is on track to surpass last year’s record trade surplus of US$1.2 trillion.

The official manufacturing PMI points the same way. It recovered to 50.1 in September from 49.8 in August, the first reading above 50 since June, and the production sub-index rose to 51.7. ING’s Lynn Song noted that manufacturing has been a relative strength this year but has been driven mostly by external demand. A two-month extension of the trade truce with the United States, until January, removes one risk to those exports for now.

Factory activity returns to growth

Official manufacturing PMI. Above 50 means expansion.

The People’s Bank holds its fire

The central bank has kept the one-year loan prime rate at 3.0% and the five-year rate at 3.5% for 16 consecutive months, most recently in September. Its seven-day reverse repo rate, which anchors them, has stayed at 1.40% since a 10 basis point cut in May 2025. Reuters analysis cited in the trade press attributes the restraint to the imported inflation from higher oil prices and to the exchange rate, and analysts add the need to protect bank profit margins.

The yuan has been firm. The ECB’s reference rates imply about 6.70 yuan to the US dollar on 6 October, compared with about 6.9 in March. A strong yuan reduces the cost of imported oil in yuan terms, which may be one reason the shock has been less painful in China than elsewhere, and it is a reason the central bank has not rushed to cut and weaken the currency. Market analysts expect that if more easing comes, it will take the form of cuts to the reserve requirement ratio or targeted lending tools, not to the headline rates.

Policy rates after the latest decisions

Latest policy rate in each economy. The US figure is the top of its target range.

Property, policy and the price war

Beijing’s policy response is aimed at the weak spots directly. A new 40-year mortgage policy was announced in September, and authorities have widened interest-subsidy programmes and begun channelling funds through a policy-backed financing facility to support local government projects. China has also set cost-accounting rules for key industrial products to curb low-price competition, the so-called “involution” in which firms cut prices below cost. Such measures may also support producer prices, although the Bureau attributes the latest rise mainly to imported costs.

The main constraint is household confidence. As long as home prices keep falling, households that own property are reluctant to spend, and the 0.4% growth in retail sales shows it.

7Three paths for the next announcement

The next loan prime rate announcement is on 20 October. The table sets out how the evidence could point in each direction. It is our analytical judgement, not a forecast.

Scenario	What it would look like	Likely stance
Hold	Prices keep rising on oil, the yuan stays firm, the PMI holds above 50 and exports stay strong.	Leave both rates unchanged for a 17th month.
Targeted easing	Retail sales and investment weaken further, and third-quarter growth falls toward the bottom of the 4.5% to 5% range.	A cut in the reserve requirement ratio or new targeted lending, with headline rates still unchanged.
Rate cut	Oil prices fall sharply, producer price inflation fades, and home prices and consumption deteriorate together.	A cut to the loan prime rate, the first since May 2025.

8What to watch

Four things will decide the next move: the path of oil prices and with it the producer price index, third-quarter GDP growth due later this month, the retail sales and home price figures, and the exchange rate. Mainland stock markets are closed for the National Day holiday this week, and the Shanghai Composite last closed at 3,842.19 on 30 September. Behind all of them stands the 20 October announcement, which will show whether the central bank regards the oil-driven price rise as something to wait out or a reason to stay on hold for longer.