China’s Bucking The Global Inflationary Trend

What happened last week?

US

• Retail sales in the US rose more than forecast in July.

Europe

• British wages grew at a record pace in the three months to June.
• Inflation in the UK dropped sharply in July, but core price gains stayed put.

Asia

• The Chinese central bank unexpectedly cut interest rates.
• Japan’s economy outstripped expectations last quarter.

What does all this mean?

US retail sales rose 0.7% in July from the previous month – well ahead of economists’ expectations of a 0.4% increase and a marked acceleration from June’s 0.3% pick-up. That data demonstrates how American households are using their rising wages to shield the US economy from a recession – but take those numbers with a grain of salt. First, the figures aren’t adjusted for inflation, meaning some of that increase can simply be explained by higher prices. Second, the numbers only reflect spending on goods, not services. And third, the data was skewed by Amazon’s Prime Day event, which significantly bolstered online sales that month.

Wages are up in the UK too, with the country’s average pay (excluding bonuses) up 7.8% in the three months to June versus a year ago. Not only did that top economist forecasts of 7.4%, it also marks the highest reading since records began in 2001. For the Bank of England (BoE), that’s a worrying signal that it hasn’t yet broken the wage-price spiral that’s feeding inflation across the economy. That’s when rising prices of goods and services encourage employees to demand higher wages, which then leads to more spending and higher inflation. And as companies raise the prices of their goods and services to offset their own higher wage costs, the loop leads to higher and higher – or “spiraling” – inflation.

Case in point: consumer prices in Britain were 6.8% higher in July than they were a year ago. While that’s slightly above the 6.7% rate expected by economists, it’s a chunky decrease from June’s 7.9% pace, mainly thanks to July’s lower energy prices. But even after the big drop off, inflation’s still more than triple the BoE’s 2% target. What’s more, core inflation – which excludes volatile food and energy prices – held steady at 6.9% in July instead of ticking down as economists had expected. Taken together, the data shows that the BoE’s job is nowhere near done.

In a bid to bolster its faltering economy, China’s central bank unexpectedly cut a key interest rate by the biggest margin since 2020. The People’s Bank of China (PBoC) reduced the rate on its one-year medium-term lending facility – the main rate used when lending to major banks – by 0.15 percentage points to 2.5% last week, the second reduction since June. A short-term policy rate was also lowered, but by 0.10 percentage points.

Meanwhile, Japan’s economy expanded at a much faster rate than forecast, with a hefty bump in exports more than offsetting weak results for both business investment and private consumption. The economy grew at an annualized pace of 6% in the second quarter from the one before – more than double the 2.9% rate forecast by economists and the strongest growth since late 2020. Nearly two percentage points of that increase came from a combination of exports including amped-up car sales, resurgent inbound tourism, and the effect of a weaker yen.

This week’s focus: China

China slid into deflation in July, highlighting the disappointing state of domestic demand in the world’s second-biggest economy eight months after it abandoned strict lockdown measures. Adding to the country’s woes, new data out earlier this month revealed that Chinese banks extended the fewest monthly loans in July since 2009. That’s a sign that demand for investment and spending money is getting even weaker, which heightens the risk of deflationary pressure sticking around for longer. No wonder, then, the PBoC is cutting interest rates in a bid to spur loan demand and, ultimately, consumer spending.

But the declining yuan is making the central bank’s job more complicated. The currency’s hovering near a 16-year low against the US dollar, with the economic outlook only darkening. Plus, with the PBoC cutting interest rates while the US central bank continues to hike them, the difference in the yields of 10-year US and Chinese government bonds has reached its biggest gap since 2007. That’s prompting investors to shift capital from China to the US, further exacerbating the yuan's decline and deterring much-needed foreign investment into the country.

The week ahead

• Monday: Earnings: Zoom.
• Tuesday: US existing home sales (July). Earnings: Baidu, Medtronic.
• Wednesday: US new home sales (July), Japan, eurozone, UK, and US PMIs (August). Earnings: Nvidia, Snowflake.
• Thursday: US durable goods orders (July). Earnings: Intuit.
• Friday: Nothing major.