Will China grow out of the extremely low inflation in 2025?

China's economic slowdown has been accompanied by increasingly pronounced and prolonged deflationary pressures. The latest release of inflation data for December 2024 confirms this concerning trend, driven by the lack of domestic demand. This raises an important question: can China grow out of the extremely low inflation in 2025?To address this question, we first break down China’s CPI into its components: goods and services. The data indicates that the goods sector has been experiencing more intense deflation compared to the service sector. This trend aligns with the general economic growth model, where households tend to allocate a larger portion of their income to services as their wealth increases.However, in China's case, this divergence is also reflective of the government's policy preferences, namely supporting the increase of industrial capacity, particularly in high tech industries to the detriment of the service economy. The fact that the service economy is less supported by government policies reflects in its more stagnant supply, compared to demand, leading to positive price developments. In particular, healthcare, travel, and education have experienced robust price growth, whereas real estate related prices keep on falling, such as rents. The latter reflects the government's crackdown on the real estate sector, which has resulted in a significant drop in demand amid a bleak outlook for housing prices.On the industrial side, the sectors behind the “new production forces” have seen a massive increase in supply without the sufficient local demand, which has resulted in growing reliance on exported goods markets. Given that protectionist winds are blowing even more strongly in 2025, the downward pressure on the price of the goods sector should persist.Still, the very low base in prices from 2024 should give some support to consumer price inflation in 2025, but it will also be important to implement more expansionary fiscal and monetary policies to support household’s income and domestic consumption.Against the backdrop, we expect China’s CPI to grow moderately to 0.8% in 2025, up from 0.2% this year with certain degree of laxer government stimulus. However, there is a risk that stimulus falls short of our expectation and the government does not to adjust the industrial policy any time soon.