China's post-lockdown rebound continues, despite Q2 GDP disappointment

China Macro: Lockdown slump in Q2 brings real GDP growth at two-year low of 0.4% yoy

This morning, Q2 GDP data and June activity data for China were published. In line with our expectations, China’s economy contracted in Q2 following the broadening of lockdowns in March and April. That said, the contraction in Q2 (-2.6% qoq s.a.) was even stronger than consensus expectations (-2.0%). Annual growth (+0.4% yoy) came in around one percentage weaker than expectations including ours, dropping to the lowest pace since the initial Covid-19 shock in Q1-2020. The economy of the Shanghai area, the trade and financial hub that experienced the most intense and longest lockdown in March/April, was much harder hit – contracting by almost 14% yoy in Q2. All in all, annual growth in the first half of the year dropped to 2.5% yoy (Q1: 4.8%), putting Beijing’s official growth target out of reach. We still expect growth momentum to pick-up significantly in the second half of the year, which was also illustrated by the PMI and activity data for June. This assumes the nationwide lockdown intensity will remain much lower than in March/April, and targeted policy easing and a relaxation of macroprudential regulations (including for real estate) will continue. That said, headwinds persist in the form of virus flare-ups combined with strict Covid-19 policies, the real estate sector, and the significant slowdown in China’s main export markets. We are currently reviewing our growth forecasts, with risks to our 2022 growth forecast of 4.2% now tilted to the downside.

June data stronger than expected, particularly retail sales

Despite the weakness overall in Q2, the activity data for June confirmed the economy continues to pick up from the trough of the lockdown slump reached in April. Retail sales came in much stronger than expected at 3.1% yoy (May: -6.7%, consensus: +0.3%), growing by 15.5% mom, with car sales showing a strong rebound. That said, retail sales growth is still much weaker than pre-pandemic rates (average 2019: 8.0%), consumer confidence is at historic lows, and virus flare-ups in Shanghai and other cities leading to new restrictions may delay a further rebound (although so far the overall lockdown intensity remains much lower than in March/April). Industrial production accelerated to 3.9% yoy in June (consensus: 4.0%, May: 0.7%). Fixed investment in urban areas grew by 6.1% yoy in January-June (consensus: 6.0%, Jan-May: 6.2%). The jobless rate fell by more than expected, to 5.5% (consensus: 5.7%, May: 5.9%). Earlier this month, the PMIs, export and lending data also confirmed China’s rebound from the lockdown slump. All in all, Bloomberg’s monthly GDP estimate jumped to a four-month high of 4.7% yoy in June. That said, the June data also show that real estate sector is still struggling, with year-to-date annual growth of property investment and residential property sales still very negative.

Credit cycle is turning, but only gradually

Meanwhile, China’s credit cycle shows signs of gradual turning following the easing of fiscal policy in particular, as well as monetary policy. The volume of new lending (aggregate financing and new yuan loans) picked up sharply in June compared to consensus expectations and to May. After having weakened significantly in April during the lockdown slump, growth of aggregate financing picked up to 11.2% yoy. The monetary aggregates also showed a further acceleration, with for instance M2 growth reaching 11.4% – the fastest pace since November 2016. Earlier this year, Beijing made clear that it will tolerate credit growth outpacing nominal GDP growth this year, implying that overall leverage in the economy will be allowed to rise further. With local bond quotas being raised and frontloaded to finance a surge in infrastructure spending, the overall credit impulse (according to Bloomberg’s 12 month measure) is just back in positive territory again.

That said, for the credit rebound to gain further strength and to last longer, a firming of private credit demand is needed, with mortgage demand being a central pillar. While the 25bp cut in the 5-year Loan Prime Rate to 4.45% (a key benchmark for mortgage rates) in May should be supportive for mortgage demand, headwinds in the real estate market remain significant. Nationwide property sales have not shown a fundamental recovery from the lockdown slump, although several regions clearly picked up in June. Moreover, a growing number of households are losing trust in property developers and banks, illustrated by recent initiatives by households to stop paying mortgage obligations for unfinished projects. All in all, distress among property developers and related parts of the financial sector has continued to spread. A more forceful approach to support the real estate sector looks essential to mitigate systemic risks and to strengthen and extend China’s credit rebound.