China Economy:Reflation broadens upstream, while final demand still lags

China Economy Reflationbroadensupstream,whilefinaldemandstilllags FrankLiu(852) 3761 8957frankliu@cmbi.com.hk YoY CPI stayed positive in Mar, although it eased from Feb as post-CNYnormalization in food and services outweighed the sharp rebound in fuel costs.Core CPI moderated as domestic demand remained soft. PPI turned positiveYoYforthe first time since Sep 2022, led mainly by energy and related sectorslike chemical productsand rubber & plastic products, while final consumergoods prices stayed subdued. We are seeing a more visible reflation inupstream sectors, but the still-weak housing and big-ticket consumption datasuggest the reflation remains uneven andisnot yet fully demand-led, whichshould compress profit margin in lower-stream sectors and consumer demand.This backdrop is constructive for upstream resources, energy, industrials andhigh-dividend value names in the near term, while a broader rerating inconsumption, property and domestic cyclicals still requires a clearer recoveryin household demand. Looking forward, we expect the CPI, PPI and GDPdeflator to reflate from 0.1%,-2.6% and-1% in 2025 to 0.8%, 1% and 0.9% in2026. The rise in price levels may push back the PBOC’s rate cut to the end of3Qwithroomfora 10bps LPR cut and a 50bps RRR cut. Source: Wind, CMBIGM CPI moderated on the back of post-holiday normalization in fooddespite surging energy prices.China’s CPI YoY softened to 1.0% in Marfrom 1.3% in Feb, below market expectation of 1.3%.In sequential terms,CPI fell 0.7% in Mar after rising 1.0% in Feb, largely reflecting the paybackafter theChineseNew Year holiday. Food inflation remained positive at0.3% YoY, but cooled from 1.7% in Feb.Food pricedropped 2.7%MoMinMar, as fresh vegetable and meat prices fell 10.1% and 3.9%, with porkdown 7.3%. By contrast, vehicle fuel prices surged 10.0% MoM as oil pricesmoved higher, liftingYoY growth to 3.4% from-9.0% in Feb.Lookingforward, food price may continue to soften, as pork and vegetable priceskeep falling in Apr, weighing on CPI, while vehicle fuel prices continue torise. Source: Wind, CMBIGM Core CPIedged down asservice inflation cooled.Core inflation easedto 1.1% YoY in Mar from 1.8% in Feb, while service inflation slowed to 0.8%from 1.6%.Core CPIfell 1.1%MoMafter rising1.1% in Feb mainlydue topost-holiday normalization, astourism prices dropped 12.9% in Mar after a14.1% surge in Feb, while home service prices fell 2.8% after rising 1.7% inthe prior month.Other services remained subdued as housing rent, telecomservice and education service remained flat and express service dropped0.5% MoM.Durable goods prices remained weak, as transport vehicleprices remained negative at-1.1% YoY, home appliance inflation slowed to2.4%from 5.3%,while telecom equipment rose to 2.6%.Prices ofnondurable goodsincluding shoes and clothing also edged down. Overall,the moderation in core and service inflation indicates that domestic demandremainssubdued and is not yet strong enough to underpin a broadconsumption-led reflation. PPI turned positive YoY but the rebound remained concentrated inenergy and upstream materials.YoY PPI rose to 0.5% in Mar from-0.9%in Feb, marking its first positive reading since Sep 2022.MoMPPIgrowthaccelerated to 1.0% from 0.4%, with production materials up 1.3%. Miningindustries surged 3.9% MoM, led by oil and gas extraction at 15.8%,whilecoal,ferrous and non-ferrous prices moderated.Raw material andprocessing industries rose 2.4% and 0.5%, respectively.Chemical productsand rubber &plastic products also surged 3.6% and 0.6% MoM in Mar drivenbycrude oil price.However,downstream sectors remained subdued:consumergoods PPI slipped 0.1%MoM,and on a YoY basis daily consumer goods and durable goods were still down 1.4% and 1.0%, automanufacturing fell 2.5%, while computer, telecom and electronic equipmentmerely turned slightly positive at 0.4%thanks to surging storage and DRAMprices. Demand-driven reflation will be essential for sustaining a moreconsistent price recovery and abroader China equity rerating.The Mardata confirmed that China’s reflation is becoming more visible, but it is stillmore commodity-led than household demand-led. The turn in PPI intopositive territory should support nominal revenue, earningsexpectationsand cash flow for upstream resources, energy,metals andindustrials. Yetdownstream demand has not fullyrecoveredas housing and vehicle salescontinuedto dip YoY,suggesting the property chain and big-ticketdiscretionary demand have yet to form a convincing upcycle. This means abroad rerating in consumer, property, building materials and other domesticcyclicals still requires stronger household income expectations and firmerpolicy transmission. We believedemand-pull reflation will prove moresustainablethan supply-induced price gains,which should keeppolicymakers inclined toward further support for households and the realestate sector.Looking forward, we expect the CPI, PPI and GDP deflator toreflate from 0.1%,-2.6% and-1%