Inflation does not equal reflation: China’s demand momentum remains weak, with policy focused on fine-tuning and structural reform

Overview

This report centers on “Inflation without Reflation,” with the core judgment that China may see localized price increases or imported price pass-through, but this is not the same as broad reflation driven by demand recovery. The report evaluates the macro outlook for China and Asia-Pacific from the perspectives of inflation composition, downstream profit margins, consumer confidence, fiscal and monetary policy, industrial policy, structural reform, and RMB internationalization.

Core views

The main views of the report are: first, energy prices and related pass-through reversed in June, but core CPI excluding gold remained weak, indicating that the demand side has not generated strong reflation; second, fiscal policy is more likely to involve execution and fine-tuning rather than an expansionary shift, and the roughly Rmb2trn of fiscal impulse room in H2 is sufficient to support implementation of the existing budget; third, the PBoC is expected to remain on hold, balancing monetary policy flexibility and financial stability; fourth, anti-involution and the unified national market are the right direction, but cross-regional capacity coordination, local incentives, and a production-oriented tax system will make execution difficult; fifth, RMB internationalization will gradually advance through the CNH market, southbound Bond Connect, offshore RMB liquidity, hedging tools, and RMB commodity settlement.

Analysis framework

The report uses a top-down macro framework, breaking inflation into price shocks, core inflation, and demand momentum, and combines this with fiscal execution room, monetary policy signals, industrial policy direction, structural reform constraints, and offshore RMB market development to assess the policy path and asset implications.

Methodology notes

• Macro Inflation AnalysisInflation vs. Reflation Differentiation Framework

  Rising prices do not necessarily represent demand-driven reflation

  The report separately examines disturbances such as energy prices, pass-through effects, and gold from core CPI and consumer confidence in order to judge whether inflation has sustainable demand-side support.

• Policy AnalysisFiscal Fine-Tuning Rather Than Policy Pivot

  Budget implementation takes priority over new expansion

  The report believes Beijing is more focused on executing the existing budget, and that roughly Rmb2trn of fiscal impulse room in H2 reduces the urgency for additional countercyclical expansion.

• Structural Reform AnalysisSupply-Demand Rebalancing Reform Framework

  Industrial policy needs to be paired with reforms to incentives, welfare, and the fiscal system

  The report points out that anti-involution and the unified national market are the right direction, but reforms to cadre evaluation, social welfare, and the fiscal tax system are needed to reduce structural problems of excess supply and high household savings.

• FX and Market InfrastructureCNH-Channel RMB Internationalization Framework

  Advance RMB internationalization through the Hong Kong offshore RMB market and controlled cross-border channels

  The report views southbound Bond Connect, RMB business facilitation, offshore government bond futures, gold clearing, and RMB-denominated commodity tools as key infrastructure for deepening the CNH ecosystem.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• CNH and offshore RMB market

  Directly benefits from RMB internationalization and offshore market development in Hong Kong

  Strengths

  A higher southbound Bond Connect quota, expanded RMB business facilitation, offshore RMB government bond futures, and cross-border gold clearing all help improve liquidity and risk management capabilities.

  Weaknesses

  The path of advancement emphasizes gradualism and control, so rapid liberalization is unlikely in the short term.

  Comparison

  Compared with the onshore RMB market, CNH is better suited as a channel for experimentation and expansion in RMB internationalization.

  Risks

  Geopolitics, capital flow management, offshore liquidity volatility, and changes in regulatory pace could affect the speed of progress.

• China rates and government bonds

  Affected by fiscal execution and the PBoC staying on hold

  Strengths

  Monetary policy stability and financial stability objectives help reduce sharp policy volatility.

  Weaknesses

  If fiscal policy is only fine-tuned rather than expanded, demand-driven reflation may provide only limited upward pressure on yields.

  Comparison

  Compared with a strong reflation cycle, the environment described in this report is characterized more by low core inflation and policy backstopping.

  Risks

  Energy prices, the fiscal pace, export changes, or policy surprises could all alter rate expectations.

• China equities and industrial policy-related sectors

  Influenced by strategic directions such as AI, quantum technology, life sciences, integrated circuits, and advanced manufacturing

  Strengths

  The national goal of becoming a technology powerhouse and industrial policy can provide sustained support for strategic industries.

  Weaknesses

  The report emphasizes that industrial policy alone may not solve supply-demand imbalances, and some industries may still face capacity and margin pressure.

  Comparison

  Compared with traditional sectors with excess capacity, frontier technology and advanced manufacturing are more aligned with policy direction.

  Risks

  Misaligned local incentives, a production-biased tax system, repeated investment, and insufficient demand may weaken policy effectiveness.

• Commodities and gold-related RMB settlement tools

  Related to the expansion of RMB internationalization infrastructure

  Strengths

  Cross-border gold clearing, RMB-denominated commodity futures, and spot products help expand the use of RMB in commodity trade.

  Weaknesses

  These tools are more about medium-term infrastructure building, and may have limited short-term impact on the actual share of trade settlement.

  Comparison

  Compared with the USD-dominated commodity settlement system, RMB-denominated products are still in a gradual expansion phase.

  Risks

  International acceptance, liquidity, regulatory restrictions, and FX volatility may limit tool usage.

Key data

• Fiscal impulse room in H2approximately Rmb2trnThe report says Beijing is more focused on budget implementation rather than budget expansion, and the existing room can support policy execution in H2 2026.
• Southbound Bond Connect quotaraised from Rmb500bn to Rmb800bnUsed to expand investment channels and deepen the role of Hong Kong as a CNH hub.
• RMB business facilitation quotaraised from Rmb200bn to Rmb500bnAt the same time, the tenor was extended to as long as three years to enhance offshore RMB liquidity.
• Offshore RMB government bond futureslaunch of 5-year offshore RMB CGB futuresUsed to enrich risk management and hedging tools.
• Inflation signalsEnergy prices and pass-through factors reversed in June; core CPI excluding gold remained weakSupports the judgment of “inflation disturbance without demand-driven reflation.”

Impact & implications

For investors, the report suggests not interpreting localized price rebounds simply as the restart of a strong demand cycle. The policy mix is tilted more toward steady-growth execution, monetary patience, and structural reform, while the key variables for rates and RMB assets lie in the pace of fiscal implementation, whether the PBoC maintains stability, the strength of anti-involution execution, and the expansion of CNH market infrastructure. Policies related to RMB internationalization may raise the medium-term strategic importance of offshore RMB bonds, FX hedging, gold clearing, and RMB-denominated commodity tools.

Risks

• Persistently weak core CPI and soft consumer confidence may cause reflation expectations to fail.
• If fiscal policy is only fine-tuned, it may be insufficient to quickly reverse weak demand and compressed downstream profit margins.
• The PBoC remaining on hold may reduce short-term policy stimulus flexibility.
• Anti-involution and the unified national market face execution challenges such as cross-regional capacity coordination, misaligned local incentives, and a production-biased tax system.
• If RMB internationalization is affected by capital flows, offshore liquidity, or external geopolitical factors, progress may be slower than expected.

What to watch

• Whether core CPI excluding gold remains subdued or shifts toward broader demand-driven inflation.
• The actual implementation pace and allocation of the approximately Rmb2trn fiscal impulse in H2 2026.
• Whether signals from the PBoC Monetary Policy Committee continue to emphasize flexibility and financial stability.
• The detailed implementation rules for anti-involution, the unified national market, and capacity coordination policies.
• Whether there is substantive progress in cadre evaluation, social welfare, and fiscal tax system reform.
• The rollout progress of CNH infrastructure such as the increased southbound Bond Connect quota, expanded RMB business facilitation, offshore RMB government bond futures, and cross-border gold clearing.