Iran Conflict Could Alleviate China’s Deflation Worries
While Beijing may not publicly acknowledge it, the American and Israeli strikes on Iran are likely to serve President Xi Jinping’s interests by mitigating the looming threat of deflation. The ongoing conflict could potentially alleviate some of the responsibilities faced by the Chinese central bank. Once regarded as a relatively uncontroversial forecast, the prospect of interest-rate cuts now appears less certain. In contrast to many economies, China did not experience the pronounced surge in inflation that typically accompanied the reopening from the pandemic. The People’s Bank of China did not find it necessary to increase borrowing costs as the Federal Reserve or European Central Bank did; its primary concern was the stagnation of demand. However, the surge in energy prices resulting from the conflict with Iran and its subsequent retaliation could provide consumer prices with the impetus required to elevate them from the perilous territory. The PBOC can afford to take a more patient approach.
China, being the largest purchaser of foreign oil and gas globally, faces significant vulnerability to rising prices. Although the second-largest economy has progressed toward energy independence, a significant portion of its crude imports passed through the Strait of Hormuz before traffic through the narrow waterway diminished considerably following the onset of the war on February 28. The PBOC reduced its key rate only once in 2025, which stands in contrast to the significant easing anticipated by numerous economists. Demands for additional cuts this year have prudently been moderated. In February, consumer prices experienced their most significant increase in over three years, likely receiving additional support from the surge in oil prices. The extended period of decreases in producer prices may be approaching its conclusion. Figures for March are set to be published on Friday. Markets indicate a positive shift has occurred. Throughout March, the PBOC effectively withdrew liquidity from the financial system during its daily operations. This represents a significant change; regulators have focused on maintaining adequate liquidity in recent years, rather than being concerned about excess liquidity. The bond market is signaling that there may be significant developments underway: The yield spread between China’s five-year and 30-year notes, which serves as an indicator of inflation expectations and supply pressures, has recently attained its widest level in approximately four years. Interest-rate swaps indicate a decline in investor expectations regarding the PBOC’s reduction of borrowing costs.
This advancement aligns China more closely with international standards. Although a hike by the PBOC remains distant, the rationale for a cut is far less definitive than it previously appeared. The Federal Reserve, which commenced the year with intentions to ease monetary policy, is now indicating that it is not in a hurry to make adjustments. Kevin Warsh, selected by the White House to take over from Chair Jerome Powell, will face challenges in convincing the Federal Open Market Committee to implement an immediate reduction in interest rates. In Europe, officials remain resolute in their commitment to prevent inflation from spiraling out of control, as it did following the Covid pandemic and the Russian invasion of Ukraine. Australia has implemented an increase, and according to Economics, further tightening is anticipated in Singapore and Japan. What constitutes “good” inflation in China? The likelihood of reaching even half of the post-Covid peak of 9.1 percent, recorded in mid-2022, remains minimal. While economists express optimism regarding the possibility of having reached the bottom, the forecasts remain relatively modest. Bank of America, which recently abandoned its prediction for two cuts by the PBOC, has revised its estimates for consumer inflation to 0.7 per cent this year from 0.1 per cent, and expects producer prices to rise by 0.3 per cent. While it may seem modest, when compared to an earlier projection of a 0.7 percent decline, it is significant. The PBOC, in contrast to numerous other central banks, lacks a formal inflation target.
The enhanced environment is not occurring in isolation, nor can it be solely ascribed to Iran. Beijing has sought to mitigate aggressive discounting by companies, as part of its anti-involution initiative. Earnings reported by industrial companies exhibited slight increases in 2025 following a prolonged period of downturns, with profits rising by 15 percent in January and February compared to the same months the previous year. The property market is exhibiting indications of stabilization following a challenging phase of weakness. The situation with Tehran has emerged at a particularly advantageous moment. The inclination has been to concentrate on the adverse aspects in recent years, much like it was deemed inappropriate to discuss potential pitfalls during China’s prolonged economic expansion. There exist certain challenges: The trade war has diminished exports to the US, while a falling birth rate is expected to pose challenges to fiscal policy. Should the upheaval stemming from the Iran situation propel the global economy into recession, China will inevitably face adverse consequences. The freedom of movement on the high seas has yielded significant benefits, and exports to the Middle East have demonstrated robust performance. It is important to recognize that the evolving global inflation dynamics have indeed affected China. This development could potentially alleviate some challenges faced by the PBOC. Should they unexpectedly opt for easing, any reduction will reflect a matter of choice rather than an urgent necessity.
