JPMorgan: China's July inflation cooling exceeded expectations; rate cut possible by year-end

Overview

JPMorgan released its commentary on China's July inflation data, noting that both CPI and PPI cooled more than expected. CPI was dragged down by falling energy and food prices, while core inflation stagnated. PPI retreated due to weakening commodity prices and weather-related disruptions to construction. Although demand related to AI and industrial upgrades supported prices for some high-end manufactured goods, overall deflationary pressure remains significant. The report projects full-year CPI average will be below 1% and maintains the baseline forecast of a potential 10 basis point rate cut in Q4.

Core views

CPI weakened more than expected, with energy and food becoming the main drags. July CPI YoY narrowed to 0.5% (both JPMorgan and Bloomberg consensus were at 0.8%), and seasonally adjusted MoM fell by 0.4%. By component, transport and communication prices dropped 3.3% MoM (seasonally adjusted), primarily driven by a sharp 10.7% MoM decline in domestic gasoline prices. Food prices fell 0.3% MoM (seasonally adjusted); although pork prices rebounded 4.1% MoM due to capacity controls and transport disruptions, they were still dragged down by other food items. Household appliance prices fell 0.9% MoM, pulling down related sub-indices. While medical prices rose due to policy adjustments and consumer electronics prices recovered due to AI upgrades, both Core CPI and Services CPI remained flat MoM, with YoY figures of only 0.9% and 0.7% respectively, reflecting insufficient endogenous momentum in resident consumption. PPI peaked and began to retreat, with industrial deflationary pressures re-emerging. July PPI MoM (seasonally adjusted) fell by 0.7%, marking the first MoM negative growth since December last year, while YoY growth slowed to 3.5% (below the expected 3.9%). The cooling of means of production prices was the primary cause. The YoY increase in raw material industries narrowed by 2.5 percentage points to 6.1%, mainly influenced by the transmission of global commodity price declines to oil, gas, chemicals, and metals. Meanwhile, adverse weather interfered with construction, depressing prices for steel, building materials, and electricity. Given that government bond issuance acceleration was limited, investment in fixed assets may still face high contraction pressures. Ex-factory prices for consumer goods fell only slightly by 0.1%, indicating relatively mild downstream transmission. Structural highlights cannot change the overall deflation trend, leaving monetary easing windows open. Indeed, demand for AI applications, high-end manufacturing, and consumption upgrades has supported prices for smart drones (+2.5% MoM), advanced materials, ships, and some smart home devices (+3.4% MoM). However, this structural upward force is relatively limited compared to widespread deflationary pressures. Looking ahead, unless the situation in the Strait of Hormuz deteriorates again, the peak in global commodity prices, especially energy, has likely passed, and PPI will continue its disinflation trend. Against the backdrop of weak consumer demand and persistent food deflation, full-year CPI average is expected to remain below 1%. Given low inflation and incomplete economic recovery, although the central bank leaned towards moderate easing and emphasized policy transmission after the July Politburo meeting, the door to further easing remains open. The report maintains the baseline forecast of a 10 basis point rate cut in Q4.

Analysis framework

The report employs a typical macroeconomic inflation decomposition analysis. First, it splits CPI and PPI into 'total vs. structure' to identify drag items (energy, food, raw materials) and support items (medical, AI electronics, high-end equipment), determining whether the drivers of inflation changes are external input factors or internal supply-demand shifts. Second, it uses 'volume-price correlation' logic to verify demand strength. It analyzes the MoM performance of Core CPI and Services CPI to remove volatile items and assess residents' true consumption willingness; it examines the divergence between means of production and consumer goods in PPI, combined with government bond issuance rhythms, to infer the actual heat of fixed asset investment and industrial production. Finally, it conducts forward-looking judgments based on an 'inflation-policy' reaction function. It places inflation trends within a dual framework of global commodity cycles (e.g., progress in Strait of Hormuz negotiations) and domestic industrial policies (e.g., AI upgrades, pig herd control) to judge inflation inflection points, thereby deriving the central bank's monetary policy operating space under the background of incomplete economic recovery.

Methodology notes

• Macroeconomic frameworkPhillips curve

  Trade-off relationship between inflation and output gap/unemployment rate

  The report implicitly applies Phillips Curve logic by observing phenomena such as flat MoM Core CPI and Services CPI and falling PPI. This implies that current insufficient aggregate demand (negative output gap) continues to pressure price levels, leading to the conclusion that expansionary policy is needed to fill the gap.

• Industry/Industrial Analysis FrameworkUpstream-Midstream-Downstream Transmission Chain

  Transmission mechanism and blockages from PPI to CPI

  The report distinguishes between the sharp decline in PPI means of production and the slight changes in consumer goods prices, analyzing why upstream commodity price declines failed to effectively boost downstream consumer inflation. This reveals the current state of poor transmission mechanisms and weak pricing power at the terminal demand level.

• Cycle and Prosperity FrameworkProsperity Inflection Point Analysis

  Judging whether PPI has passed its peak

  By combining global commodity price trends, geopolitical negotiation progress, and domestic weather disruptions, the report comprehensively judges that PPI YoY growth has likely peaked. This is a typical analytical method using multi-factor resonance to confirm cyclical indicator inflection points.

Key data

• July CPI YoY0.5%Below JPMorgan and market expectation of 0.8%, previous value 1.0%
• July CPI MoM (SA)-0.4%Significant weakening, previous value -0.1%
• July PPI YoY3.5%Below expectation of 3.9% and JPMorgan forecast of 4.1%
• July PPI MoM (SA)-0.7%First MoM negative growth since December last year
• Domestic Gasoline Price MoM (NSA)-10.7%Largest drag on CPI, driving transport and communication sub-index sharply lower
• Core CPI YoY0.9%Flat MoM, reflecting slow recovery in domestic demand
• Q4 Rate Cut Forecast10bpOne rate cut still anticipated before year-end under baseline scenario

Impact & implications

For the macro economy, the comprehensive weakening of inflation data confirms that the contradiction of insufficient effective demand remains prominent, particularly the stagnation of core inflation indicates that the recovery of resident income and consumption confidence requires time. For policymakers, the low inflation environment provides ample space for further monetary easing, avoiding price constraints, but also warns that relying solely on money supply may face liquidity trap risks, requiring coordination with fiscal stimulus. For major asset classes, the bond market retains support under weak fundamentals and easing expectations. Regarding stocks, overall valuation expansion is limited, but structural sectors like AI and high-end manufacturing, which possess independent pricing logic, may gain relative excess returns. In the commodities market, caution is advised regarding correction risks after PPI peaks, especially for ferrous varieties related to real estate and infrastructure.

Risks

• Breakdown of Strait of Hormuz negotiations or intensified shipping interruptions could cause energy prices to surge again
• Persistent extreme weather disrupting construction and agricultural product transportation, causing short-term abnormal price fluctuations
• Slower-than-expected acceleration in government bond issuance, further increasing pressure on fixed asset investment contraction
• Price increase effects from AI and industrial upgrades weaker than expected, unable to hedge against widespread deflation

What to watch

• Subsequent progress of Strait of Hormuz negotiations and recovery of energy supply
• Rhythm of government bond issuance and speed of physical workload formation
• Whether the central bank implements a 10 basis point rate cut in Q4 and the effectiveness of policy transmission
• Whether price indices for AI and high-end manufacturing products can continue to strengthen
• Subsequent impact of hog capacity control measures on food inflation