In the midst of China's descent into deflation, concerns are rippling through global financial markets. However, financial experts assert that this shift may not necessarily be detrimental.
The decline in prices within the world's second-largest economy is expected to have a cascading effect, potentially lowering costs on a global scale. Given China's pivotal role as the world's manufacturing powerhouse, this dip in inflation could provide central banks with the leeway to abstain from further interest rate hikes. In fact, it might even prompt a shift towards easing policies to prop up decelerating growth.
Image source: Bloomberg
This prospect of alleviated global inflation could be a silver lining amid China's struggle to regain stability post the Covid-19 surge. Factors such as a property downturn and issues within the shadow banking sector are likely to keep inflation in check, restraining spending and investments by both consumers and enterprises.
Christopher Hiorns, a portfolio manager at EdenTree Investment, highlights that a weakened China might accelerate the peak of monetary tightening. Moreover, it could reduce demand for commodities, subsequently tempering inflation and potentially enabling Western economies to operate at a heightened pace.
However, the export of deflation from China could also bring about a slowdown in Asia and Europe. This, while positive for global bondholders and emerging-market assets, might pose challenges for these regions.
It's worth noting that the implications of China's deflation on major consumers like the US and other trading partners are likely to be modest and temporary. Shifts in US purchases of Chinese goods and the ongoing conflict in Ukraine impacting commodity prices are factors to consider.
In addition, further stimulus measures initiated by the Chinese government might help mitigate the economic downturn and stabilize prices. The recent unexpected reduction in a key interest rate by the People's Bank of China underscores the growing concern regarding the deteriorating economic outlook.
Gary Dugan, Chief Investment Officer at Dalma Capital Management Ltd., emphasizes that the weakness in China's economy and signs of deflation are clear mitigators of global inflation. However, he suggests that Chinese authorities are unlikely to remain passive in the face of these challenges.