China's factories slip back into contraction as demand stays soft

What happened

China's official manufacturing purchasing managers' index (PMI) fell to 49.3 in October from 50.1 in September, the National Bureau of Statistics said on 31 October. A PMI is a monthly survey of company managers: above 50 means more of them report rising activity than falling, below 50 the opposite. Economists polled by Reuters had expected 50.0. Reuters reported that soft demand, including for exports, weighed on factories.

It reverses September's small improvement, when the index had risen to 50.1 from 49.8 in August.

Why weak demand shows up in prices and bond yields

When demand is soft, firms struggle to raise prices, and some cut them to win orders. That is why China's consumer inflation was only 0.9% in September, while the United States, the euro area and Britain are dealing with rates between about 3% and 4%. The same oil shock that lifted inflation elsewhere has had a much smaller effect in China, where the bigger problem is too little spending.

Bond markets read the same signal. With low inflation and a central bank that keeps its own rates low (1.4% for its main seven-day rate), investors accept low yields: China's 10-year government bond yielded about 1.65% on average in October, less than half the US level. That gap is one of the clearest differences between China's economy and the rest of the world's this year.

Why it matters beyond China

China is the world's largest manufacturer and exporter. Weak demand at home pushes its firms to sell more abroad, often at lower prices, which helps hold down goods prices elsewhere but adds to trade tensions. A slower China also buys fewer raw materials, from iron ore to copper, which matters for exporters such as Australia and Brazil.

Where it sits in the chain

This is Link 5, the real economy, with a twist: where weak growth elsewhere is mostly caused by high interest rates, in China it is the reason rates stay low.

What to watch

• China's trade figures and October inflation, due in early to mid-November.
• Any new support for households or property from Beijing.
• The private-sector PMIs published in the coming days, which cover more export-oriented and smaller firms.