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Corporate and Investment Bank
Standard Bank Group
Inside China 28 January 2026

China trapped in low inflation

Jeremy Stevens

  • Q4:25 delivered the steepest slowdown since 2020: property sank further, investment turned negative, and nominal GDP slowed for a fourth straight year, to 3.8%.
  • Deflation is entrenched: headline CPI was flat, PPI -2.6%, and the GDP deflator negative for 10 quarters. Markets now price 2026 CPI at 0.5-0.7% and PPI at -1.5%.
  • Factory-gate deflation bites producers: with PPI at -2.6%, and the real borrowing cost for manufacturers exceeding the 1.4% prime rate, this chokes margins and deters fresh capex – despite ample liquidity.
  • The textbook prescription for such conditions is aggressive rate cuts, quantitative easing, and forward guidance promising sustained accommodation. However, the medicine has been administered in only microdoses: a single 25 bps policy rate cut in 2025.
  • This is unlikely to change in 2026. The PBoC will be very cautious until bank net-interest margins (now a record-low 1.42%) start to improve as balance-sheet repair trumps stimulus – especially as it will likely be ineffective.
  • Monetary policy is impotent because the transmission mechanism is blocked at both ends: households, already saddled with mortgage-service burdens equal to 115% of disposable income and a 20% slide in the value of their homes, refuse to borrow, however cheap credit becomes, while banks (whose net interest margins have been crushed to a record low 1.42%) cannot find creditworthy firms willing to invest amid excess capacity.
  • Any cut in the policy rate merely lowers the government's borrowing costs and pushes up bond prices, rather than reach the real economy where prices are set.
  • Credit guidance is the substitute: CNY1.9tn of cheaper relending quotas for SMEs, tech and private firms. However, it would be unsurprising if much of the quota was drawn anytime soon to refinance existing loans.
  • Notably, NPL pressure will rises as forbearance ends. Special-purpose refinancing tools expire in H1:26. An additional 0.8-1.2 ppt of NPLs may surface once developer and LGFV moratoria are lifted, requiring more provisioning from skinny profits.
  • Fiscal space has shrunk: Beijing reports a 5.1%-of-GDP general-government deficit, but once LGFV bonds, policy-bank loans and other quasi-fiscal channels are added, the true augmented shortfall is about 9% of GDP – roughly CNY12tn of new borrowing in 2025. Every extra percentage point raises debt-service faster than nominal growth, meaning that a 2008-style blast that alters inflation expectations is impossible.
  • Bottom line: markets price 2026 CPI at 0.5-0.7%, PPI at -1.5% and the one-year LPR barely 20-30 bps lower – whatever the Fed may do.   
 

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