China's factory-gate deflation worst in 22 months as economic headwinds mount

BEIJING (Reuters) -China's producer deflation deepened to its worst level in almost two years in May while consumer prices extended declines, as the economy grappled with trade tensions and a prolonged housing downturn.

Uncertainties from a tariff war with the United States and weak consumption at home have rattled sentiment and fuelled expectations of more policy stimulus to combat deflationary pressures.

The producer price index fell 3.3% in May from a year earlier, worse than a 2.7% decline in April and the deepest contraction in 22 months, National Bureau of Statistics data showed on Monday. That compared with an estimated 3.2% fall in a Reuters poll.

"China continues to face persistent deflationary pressure," said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

"The price war in the auto sector is another signal of fierce competition driving prices lower. I am also concerned about the property prices which resumed their downward trend in recent months after a period of stabilization," he said.

With households cautious about spending due to income pressures, some companies have resorted to price discounts to boost sales, prompting the authorities to urge an end to the auto industry's bruising price wars.

Cooling factory activity also highlights the impact of U.S. tariffs on the world's largest manufacturing hub, dampening faster services growth as suspense lingers over the outcome of U.S.-China trade talks set to resume in London on Monday.

In a phone call on Thursday, U.S. President Donald Trump and Chinese leader Xi Jinping discussed trade tensions and critical minerals, leaving key issues for further negotiations.

The consumer price index dipped 0.1% last month from a year earlier, after falling by the same amount in April and slightly better than a Reuters poll forecast of a 0.2% decline.

CPI slid 0.2% on a monthly basis, compared with a 0.1% increase in April, and matched economists' predictions of a 0.2% decline.

Fragile domestic demand remains a drag on China's economy despite a recent flurry of policy support measures.

Retail sales growth slowed last month as spending continued to lag amid job insecurity and stagnant new home prices.

The core inflation measure, excluding volatile food and fuel prices, registered a 0.6% year-on-year rise, slightly faster than a 0.5% increase in April.

However, Zichun Huang, China Economist at Capital Economics, said the improvement in core prices looks "fragile", adding "we still think persistent overcapacity will keep China in deflation both this year and next."

(Reporting by Qiaoyi Li, Tian Qiao and Ryan Woo; Editing by Jacqueline Wong and Shri Navaratnam)