China: Drop in Caixin PMI in August suggests substantial weakness in Q3

China’s flash Caixin (previously HSBC) manufacturing PMI declined in August to 47.1 (consensus: 48.2) from a final reading of 47.8 in July. This is the lowest level since March 2009.

There was weakness across the board with new orders declining to 46.3 from 47.2 and export orders down to 46.0 from 46.9. So both domestic demand and exports appear to have weakened. Inventories also increased, with the finished goods inventory component increasing again to 50.4 from 49.9 in July. Hence, the new orderinventory- balance has deteriorated markedly in the past two months, suggesting no imminent turnaround in the manufacturing PMI.

These figures obviously suggest that GDP growth will ease in Q3. It should be remembered that Chinese data is mixed at the moment as recent data suggests some recovery in the housing market. We expect GDP growth to ease to 6.6% y/y in Q3 from 7.0% y/y in Q2 and hence to drop substantially below the government’s 7% growth target.

This suggests pressure will remain on the People’s Bank of China (PBoC) to ease further. We expect the bank to cut its leading interest rates by 25 bps soon. The reserve requirement ratio will probably be cut aggressively partly to offset the negative impact on liquidity from the PBoC’s recent intervention in the FX market.

The PBoC’s current attempt to stabilise USD/CNY through substantial intervention in the FX market is not unproblematic, because it might limit its ability to push down domestic money market rates. Hence, there is a question mark about the sustainability of its attempt to stabilise USD/CNY in a tightly managed exchange rate regime.of its attempt to stabilise USD/CNY in a tightly managed exchange rate regime.