China: growth accelerates and firmer H2 outlook

China’s GDP growth in Q2 accelerated to 7.5% y/y (consensus: 7.4% y/y, DBM: 7.4% y/y) from 7.4% y/y in the previous quarter. Seasonally adjusted GDP growth in Q2 accelerated to 2.0% q/q (consensus: 1.8% q/q, DBM: 1.8% q/q ) from 1.5% q/q in Q1 (revised up from 1.4% q/q).

Industrial production in June accelerated to 9.2% y/y (consensus: 9.0% y/y, DBM: 9.1% y/y) from 8.8% y/y in May. Seasonally adjusted industrial production increased 0.9% m/m in June after also increasing 0.9% m/m in May according to our calculations. Overall the monthly gains in industrial production have picked up pace since the start of the year, broadly in line with the recent improvements in the manufacturing PMIs (see chart below).

In the June data there are also signs that investment data have started to firm after substantial weakness earlier in the year. Growth in fixed asset investment in June improved to 17.3% year-to-date y/y (consensus: 17.2% year-to-date y/y) from 17.2% year-to-date y/y in May. According to our calculations growth in fixed asset investments in June accelerated to 18.7% y/y from 16.6% y/y in May. There has been improvement in manufacturing investments and investments in transportation/infrastructure, while housing investment remains weak (see chart below). So far no clear evidence of a turnaround in the housing market (see chart below).

Growth in retail sales in June eased slightly to 12.4% y/y (consensus: 12.5% y/y, DBM: 12.3% y/y) from 12.5% y/y in May. Our calculations suggest that the slower growth in retail sales in June was mainly driven by lower retail price inflation.

The data released today confirm that the Chinese economy is recovering moderately and also suggest some upside risk to our growth forecast. The current recovery appears to be driven mainly by a stabilisation in domestic investment demand and some improvement in exports. The stronger investment demand is partly driven by the government’s mini fiscal stimulus. However, the weak housing market continues to weigh on growth and is currently the biggest downside risk in the short run but we expect the housing market to gradually weigh less on growth in H2 14.

We expect GDP growth to continue to accelerate in the current quarter but ease a bit again in Q4, as the impact from the government mini fiscal stimulus starts to wane. Our message so far has been that the manufacturing PMIs would peak in late Q3 around 52. However, at the moment leading indicators are firming. Data released yesterday showed that both credit growth and money supply growth were quite strong in June. Hence, there are indications that the peak in the manufacturing PMIs could be later and at a higher level. We revise our GDP growth forecast for 2014 slightly higher to 7.5% from previously 7.4% on the back of the better-than-expected data.

With GDP growth on track to meet the government’s 7.5% target for 2014 we are unlikely to see any major easing of monetary and fiscal policy from here. Interest could be cut if the downside risk from the housing market materialises. Firmer growth should pave the way for a moderate appreciation of CNY in H2 14.