Thursday, June 25, 2015

China starting to stabilise?

We have seen a sharp slowdown in the growth rates of key China activity indicators over the first half of 2015.  That has led to the stepping-up of easing measures to now include three interest rate reductions since November last year, cuts in the Required Reserve Ratio (RRR) and a number of fiscal stimulus initiatives.  Most recent activity data suggests those measures may be starting to have an impact on the economy.  But with inflation still low and spare capacity still high further easing measures remain likely over next few months.

The Manufacturing PMI from Markit/HSBC came in at 49.6 for June, still below the 50 benchmark but up on the 49.2 recorded in May.  Importantly the improvement came in the production and new orders (more precisely new export orders) components supporting the contention of a stabilisation in activity.  Indeed this result suggests the official PMI index will tick higher in June.

But it wasn’t all good news – the employment index dipped further to 46.8.  While we tend to focus mostly on the growth indicators it’s important not to under-estimate the importance of the labour market in the Government’s policy considerations.

The PMI followed the release of May activity data which saw growth in fixed asset investment picking up slightly, driven by manufacturing and property.  That coincides with a small uptick in property prices in May, the first monthly increase since April last year. The recovery is being led by the Tier 1 cities (Beijing, Shanghai, Guangzhou etc).  We’ve previously identified stabilisation in the property market as critical for broader economic stability.

Growth in industrial production also picked up in May.  While it doesn’t look like much a turnaround yet, the better result comes off a low base last year.  Stronger export growth is driving the improvement right now but we expect recent easing measures will see improved domestic demand kicking in later this year.

Credit and money supply growth also supported the stabilisation story in May.  M2 growth accelerated to 10.8% in May, up from the historical low of 10.1% in April, the likely direct result of the recent policy loosening.  Lending growth appears to be leveling out at around the 14% level.

However disinflationary pressures remain strong.  The annual rate of non-food inflation is running at or just below 1%. Low commodity prices are having a significant impact but weak domestic demand is also an important factor in continued low CPI inflation.

Official GDP growth is likely to come in at around 6.7% in June, down from 7.0% in March.  Early signs are we will see a stabilisation at that level into the third quarter.  Until that becomes more certain, and we start to see some improvement in labour market indicators, we expect the Government to continue to ease with further cuts to the RRR and interest rates in the months ahead.