China Returns to Deflation: Concerning Signs for the Global Economy

March 17, 2025 — FXRK Weekly Market Recap

China has re-entered deflation territory, a phenomenon not seen in over a year, raising serious concerns about the stability of its economic recovery. In February, the Consumer Price Index (CPI) fell by 0.7% year-on-year, a sharper decline than the 0.4% drop predicted by analysts. This downturn suggests that domestic demand remains weak and that the country has yet to achieve a sustained recovery following the post-pandemic crisis and the challenges in the real estate sector.

Deflation is a worrisome sign as it can trigger a negative cycle in which consumption and investment contract, affecting economic growth. Although Chinese authorities have implemented various stimulus measures, the results so far have been insufficient to generate a solid economic rebound.

Factors Behind the Price Decline

The recent drop in prices in China is due to a combination of structural and cyclical factors affecting the dynamics of its economy.

Weakness in Domestic Demand

• Despite the post-pandemic reopening, consumer spending has not recovered strongly.
• Uncertainty about employment and income has led households to be more cautious with their expenses.
• Savings remain high, reducing pressure on prices.

Negative Core Inflation

• Excluding food and energy, consumer prices fell for the first time since 2021.
• This is a clear sign that the contraction in prices is not solely due to external factors or specific products but rather a generalized slowdown in consumption.

Decline in Producer Prices

• Producer prices, which reflect what factories charge wholesalers, fell by 2.2% in February, accumulating 29 consecutive months of declines.
• This trend suggests that industrial demand remains weak, affecting corporate profitability and discouraging investment.

Seasonal Impact of the Lunar New Year

• The Lunar New Year holiday, which occurred earlier than usual this year, may have temporarily influenced prices.
• However, even after adjusting for seasonal effects, the overall trend shows persistent weakness in demand.

Economic Consequences of Deflation in China

The return of deflation poses significant risks to the Chinese economy and its ability to sustain stable growth in the coming years.

Discouraging Consumption

• In a deflationary environment, consumers tend to delay purchases, expecting even lower prices in the future.
• This slows domestic demand and harms key sectors such as retail and manufacturing.

Reduction in Business Investment

• The decline in prices erodes corporate profit margins, which could lead to lower investment in new factories, technology, and hiring.
• Manufacturing and technology sectors could be particularly affected, given their high exposure to domestic and international demand.

Impact on Income and Employment

• With tighter profit margins, companies may choose to freeze wages or reduce their workforce.
• A slowdown in employment would further weaken consumer confidence, reinforcing the deflationary spiral.

Increased Debt Burden

• In a deflationary environment, prices and wages fall, but the value of debt remains constant, increasing the financial burden on businesses and households.
• This is particularly concerning for the real estate sector and highly leveraged companies, which could face greater difficulties in meeting their financial obligations.

Possible Responses from the Chinese Government

The Chinese government has implemented various measures to stimulate the economy in recent months, but the results have been mixed. Given the new deflationary context, efforts are likely to intensify in the following areas:

Interest Rate Cuts

• The People’s Bank of China is expected to further reduce interest rates to encourage credit and consumption.
• However, rate cuts have a limited impact if consumer and business confidence remains weak.

Increased Public Spending

• The government may increase infrastructure investment to boost the economy, as it has done in previous crises.
• This type of stimulus can be effective in the short term but raises concerns about public sector debt.

Consumer Support Measures

• Subsidies or incentives could be implemented to encourage the purchase of durable goods, automobiles, and homes.
• Consumption taxes could also be reduced to stimulate demand.

Support for the Real Estate Sector

• The real estate sector has been one of the main sources of instability in the Chinese economy in recent years.
• A new rescue package or easing of financing restrictions for developers could be a key measure to prevent a deeper slowdown.

Impact on Global Markets

As the second-largest economy in the world, China has a significant impact on global financial markets. Deflation and a possible slowdown in its growth could affect various sectors and countries:

Commodity Exporters

• Countries such as Brazil, Australia, and Chile, which depend on Chinese demand for mineral and agricultural exports, could face downward pressure on their economies.

Multinational Companies with Strong Presence in China

• Major corporations in the technology, automotive, and luxury goods sectors may see their revenues and profit margins decline due to lower Chinese consumer spending.

Emerging Markets in Asia

• A weaker Chinese demand could negatively impact Asian countries that depend on trade with China.

Global Monetary Policy

• Weakness in China could reinforce the narrative of lower interest rates globally, influencing decisions by the Federal Reserve and other central banks.

Conclusion

China’s return to deflation is a clear sign that its economic recovery remains fragile and that the risks of a prolonged slowdown are increasing. While Chinese authorities have taken measures to revive the economy, the structural problem of weak domestic demand suggests that more aggressive stimulus may be needed in the coming months.

For global markets, China’s economic trajectory will be crucial in 2025. The key question now is whether stimulus policies will successfully reverse the deflationary trend or if China will face a prolonged slowdown with global repercussions.

Disclaimer

The information and data published in this report were prepared by the market research department of FXRK. Publications and reports of our research department are provided for informational purposes only. Market data and figures are indicative, and FXRK does not trade any financial instrument or offer investment recommendations and decisions of any type. The information and analysis contained in this report have been prepared from sources that our research department believes to be objective, transparent, and robust