Is China emerging from deflation? It might seem preposterous to ask such a question judging by the latest batch of grim economic data. Last month, consumer prices slipped back into negative territory, having contracted in annualised terms for five of the last seven months.
Moreover, industrial output and retail sales expanded at the slowest monthly pace this year, while fixed-asset investment in the first eight months of 2025 suffered the steepest contraction for the period since the acute phase of the Covid-19 pandemic in 2020.
Other signs of deflationary pressures include the sharper decline in new home sales last month and weaker-than-anticipated credit growth in July, with the first contraction in new lending to financial institutions since July 2005. Societe Generale said that “with two consecutive months of weak data, the slowdown is happening earlier than we had anticipated”.
Yet if deflation fears are intensifying, why was the Shanghai Composite Index the world’s second-best performing major financial asset last month and the best-performing leading stock market? On August 18, the index hit its highest level in a decade even though onshore equities are more exposed to “deflation-affected sectors” such as consumer staples, materials and heavy industrials, according to Morgan Stanley data.
More strikingly, why are Chinese government bond yields rising instead of falling, which is what usually happens when growth slows sharply? China’s 30-year bond yield has risen from 1.8 per cent in June to 2.1 per cent, while its 10-year equivalent stands at 1.8 per cent, up from 1.6 per cent in July.
There are a number of factors at work. One of them is the sharp rotation out of bonds into stocks over the past several months as investors desperately seek higher returns in a low-yielding environment.
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