China’s economic recovery tested as Covid outbreaks persist

China will likely announce a further economic improvement in July, although the extent and durability of this recovery is uncertain as Covid outbreaks continue to expand and a property slump persists.

A number of key indicators, including industrial output and retail sales, are likely to have improved last month as business and consumer activity gradually increased following the worst of the Covid lockdowns in the second quarter, according to official data that will likely be released on Monday.

The government will release the information formally on Monday morning, reports Bloomberg.

However, the economic outlook may be mixed, as real estate investment may have slowed and the unemployment rate may have stayed elevated. Independent high-frequency statistics have also cast a more pessimistic image of the economy's outlook, with truck traffic — a proxy for economic production — considerably lower in July compared to the same time last year and home sales plummeting compared to July of last year.

With policy makers signaling a "wait-and-see" attitude toward more stimulus and inflation creeping up, the data for July will offer important clues on the policy direction for the rest of the year.

Here's what to look for on Monday:

Retail Sales

According to the median forecast in a Bloomberg survey of economists, retail sales increased 5% year on year in July, up from 3.1% in June when Covid regulations were lifted.

Automobile sales were also up last month as a result of friendly policies, including as subsidies and tax cuts, implemented this year to entice customers. Spending on transportation and accommodation may have increased due to seasonal demand for summer holidays.

The rebound could be short-lived though as Covid outbreaks in popular tourism destinations in August put a brake on spending and travel. Authorities recently shut down parts of Tibet's capital and left thousands of tourists stuck on the tropical island of Hainan to contain infections.

Although Hainan's economy accounted for just 0.6% of China's GDP and 0.5% of retail sales in 2021, the flareup will probably fuel concerns about the risks involved in traveling -- damping tourism more widely and hurting consumption sentiment, Bloomberg Economics wrote in a note.

Investment

As policymakers pushed for a quickening of the development of large infrastructure projects, growth in fixed asset investment likely maintained steady in July. Economists anticipate a 6.3% increase in the seven months leading up to July, which is similar to the 6.1% increase predicted for the first half of the year.

Manufacturing investment also likely got a boost from strong export demand, along with improving profitability due to a moderation in price pressures.

Property investment, however, likely slowed further in July amid a widening mortgage boycott crisis and weakening buyer confidence. China's top 100 developers recorded combined contract sales that plunged 40% from a year earlier, China Real Estate Information Corp. data showed. Economists expect property investment to contract 5.6% in the January-July period, compared to a drop of 5.4% in the first six months of the year. 

Industrial Output

The industrial sector's recovery momentum likely remained intact: The industrial output is anticipated to have increased 4.4% in July, up from 3.8% in June, according to survey results.

However, weaker-than-expected official and private purchasing managers indexes pointed to softer manufacturing activity. While Covid disruptions to supply chains have eased in general, regional flareups are still causing hiccups. 

Jobless Rate

Jobs figures are gaining prominence as top leaders minimize the country's GDP growth target of "about 5.5%" in favor of emphasizing price and employment stability.

China's unemployment rate likely remained heightened in July, with economists expecting the surveyed jobless rate to stay unchanged at 5.5%. That's the ceiling Beijing set for the full year.

Investors should also be looking under the hood for signs of any improvement in the jobs rates for the most vulnerable groups. Summer months usually see a seasonal spike in unemployment as graduates enter the job market.

The pressure is especially great this year with the number of students graduating hitting a record 10.76 million. The frequent Covid outbreaks also bode ill for migrant workers, as authorities might shut down construction sites and restaurants once there's a flareup.

Liquidity Action

The People's Bank of China will have an opportunity to drain funds from the banking system through policy loan operations on Monday, which would help rein in risks created by excessive liquidity.

Eight out of 12 analysts polled by Bloomberg forecast the PBOC will roll over only part of the 600 billion yuan ($88.8 billion) of maturing one-year medium-term lending facility, with the median estimate at 400 billion yuan. That would be the first monthly drainage since December 2021.

The interest rate for the MLF will likely remain unchanged at 2.85%, according to the consensus estimate, as rising inflation risks restricts the room for further monetary easing.

Cash has been piling up in the market for the past few months, and has struggled to turn into loans that benefit the real economy. Seven-day interbank borrowing costs have slumped to a two-year low and are far below the short-term policy rate. The increase in leveraged bond trading may lead to financial risks should liquidity start to tighten, a former PBOC official warned.