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Shoppers on Nanjing East Road in Shanghai.

(Bloomberg) — China’s economy clocked its deepest slowdown of the year in July, raising expectations for Beijing to roll out more stimulus this year to offset the impact of Donald Trump’s trade war.

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A campaign to curb overcapacity at home is adding to the sting of higher tariffs. Fixed-asset investment fell the most since Covid erupted in early 2020, with industrial activity growth the weakest in eight months — a sign that a front-loading factory boom to get ahead of US duties of more than 50% is waning.

Weaker spending on infrastructure and consumption was also a key culprit behind the slowdown, revealing the extent to which private demand remains frail.

“It does seem like the US tariffs are just starting to bite,” said Duncan Wrigley, chief China economist at Pantheon Economics. “Domestic demand is sluggish, but don’t underestimate China’s preparations for a protracted trade war. They have been holding back support measures to use for if and when exports really start to slow.”

Taken together the data could give Trump’s trade negotiators more leverage as they look to put pressure on President Xi Jinping’s government, which is one of the last to hammer out a deal with the US. The American leader got his own economic warning this week, with wholesale inflation data showing companies now passing on tariff costs to consumers.

While China is on track to hit its growth goal of about 5% after posting a 5.3% expansion in the first half, economists at Nomura Holdings Inc. and Commerzbank AG said it’s likely only a matter of time before Beijing responds with greater stimulus.

Bloomberg Economics expects the People’s Bank of China to ease its policy further as soon as September.

“In the short-run, the cost of addressing overcapacity and deflation could be even weaker growth,” Rob Subbaraman, chief economist at Nomura, said in a note Friday. “Beijing will very likely rush to roll out a new round of supportive measures in the second half.”

This week, Trump extended a pause for elevated tariffs on Chinese goods for another three months, stabilizing trade ties but failing to lift the uncertainty over the world’s two largest economies.

For much of this year, China’s exports have remained a bright spot despite a drop in shipments to the US after Trump raised tariffs.

But a slowdown is creeping in for exports, with Pantheon estimating their growth in July slowed to 0.2% month on month, in seasonally adjusted terms, down from 0.4% in the previous month.

The deceleration of economic growth in July was worse than expected and broad-based. Retail sales grew at the weakest pace since December, according to data published on Friday, while the property market deteriorated again.

Fixed-asset investment fell around 5.3% in July from a year ago, the worst reading since the outbreak of Covid in January and February of 2020, according to economist estimates based on official data.

Private companies, which have been reluctant to expand in recent years, reported the worst contraction in investment since September 2020 in the first seven months. Capital expenditure by manufacturers grew at the slowest pace in more than a year during the same period.

National Bureau of Statistics spokesperson Fu Linghui pointed to the “continued impact of trade protectionism and unilateralism” and said extreme weather in some regions also put pressure on economic activities.

What Bloomberg Economics Says…

“Such a rapid loss of momentum still points to deeper risks such as weak sentiment. We expect the government to step up stimulus. Indeed, the recent soft credit data may prompt the People’s Bank of China to ease further as soon as September..”

— Chang Shu and Eric Zhu. For full analysis, click here

While Beijing has so far chosen to keep major stimulus in reserve for any slowdown ahead, authorities this week announced more modest measures such as a plan to subsidize part of the interest payments on some consumer loans.

The PBOC last eased monetary policy in May, when it reduced interest rates and lowered the amount of cash lenders must keep in reserve.

The government’s existing fiscal stimulus provided less of a spark in July, as a temporary funding shortage curbed consumer subsidies while extreme weather likely delayed infrastructure construction.

Further pressure also came from Beijing’s crackdown on destructive price wars, as manufacturers responded to a call to rein in excessive factory production.

Investment in sectors that include industries such as batteries and solar panels worsened significantly in July, according to Nomura, spanning industries where some of the most intense price wars continue to rage.

Even so, in inflation-adjusted terms, the economy still expanded around 5% in July from a year ago, based on estimates from Goldman Sachs Group Inc. Growth may rebound modestly in August as seasonal factors such as extreme weather pass.

Looking ahead to September, Morgan Stanley analysts said the economy is on track to worsen once more from the payback of earlier export front-loading and declining impact of consumer subsidies.

“Economic activity in the first half exceeded expectations, driven by the front-loading of exports and transshipments,” said Carlos Casanova, senior Asia economist at Union Bancaire Privee in Hong Kong. “However, the second half is likely to reflect a more tempered reality.”

Pantheon Economics

China’s Economy Slows, Boosting Stimulus Hopes