BEIJING (Reuters) - China’s factory gate prices shrank for the first time in three years in July, stoking deflation worries and adding pressure on Beijing to deliver more stimulus as the economy sputters amid an intensifying trade war with the United States.

FILE PHOTO - Woman work on manufacturing electric bicycles at a factory in Huaian, Jiangsu province, China May 26, 2019. Picture taken May 26, 2019. REUTERS/Stringer

With demand slowing at home and abroad, Chinese manufacturers are having to cut prices to keep market share, depressing profit margins and discouraging the fresh investment needed to get the economy back on its feet.

Falling prices for crude oil, iron ore and other raw materials are also playing a part.

China’s producer price index (PPI) fell 0.3% from year earlier in July, the National Bureau of Statistics (NBS) said on Friday.

That compared with zero growth seen in June and a 0.1% drop expected by analysts in a Reuters poll.

It was the first contraction on an annual basis since August 2016, though the index have now dropped sequentially for the last two months. PPI is one gauge of corporate profitability.

“Weak demand has started to impact expectations on the production side,” analyst Zou Qiang at Everbright Pramerica Fund Management said in a note.

Zou expects the price contraction to worsen in the coming months due to stricter curbs on the property sector, as regulators try to rein in debt risks and tame rising home prices.

Producer inflation in other major economies such as the United States and Germany has also been tepid lately, raising questions about the durability of global demand as the year-long U.S.-China trade war looks set to get longer and costlier.

The Chinese industries which saw the steepest factory price declines included oil and gas extraction, and paper and paper product manufacturing, with falls of 8.3% and 7.1% from a year earlier, respectively.

Energy processing firms such as oil refiners and chemical producers also saw extended price declines.

Prices for some major building materials such as steel reinforcing bars were weak in July as high temperatures and rain stalled construction projects.

POLICY OPTIONS

While trade data on Thursday showed China’s exports unexpectedly returned to growth in July, analysts warn the rebound could be short-lived as Washington prepares to slap even more tariffs on Chinese goods. Indeed, China factory activity suggested no let-up in pressure, with export orders dwindling due to weak global demand.

The Sino-U.S. trade row deepened abruptly last week after U.S. President Donald Trump said he would impose 10% tariffs on the remaining $300 billion in Chinese imports from next month.

China’s manufacturing investment growth has already slowed to 3% in the first half of 2019 from 9.5% in all of 2018, according to estimates from Nomura, and additional tariffs are likely to depress such spending further.

Weakening producer prices could add to worries about debt problems and default risks for Chinese companies as economic growth cools to near 30-year lows.

The central bank is expected to further cut banks’ reserve requirements (RRR) in coming months to free up more funds to lend, on top of six reductions since early 2018. The government has also tried to ease pressure on corporate balance sheets by cutting taxes and fees.

But policy sources say more aggressive action like interest rate cuts are a last resort, given worries about high levels of debt leftover from massive stimulus sprees in the past.

China’s central bank governor Yi Gang said last month that the current interest rate level is appropriate, and said cutting them would depend on economic conditions.

“Cutting interest rate will mainly deal with the danger of deflation, but price changes in China remain moderate,” he said in an interview with financial magazine Caixin.

Recent depreciation in the yuan could help relieve some of the downward pressure on headline producer inflation by raising import costs, ANZ analysts wrote in a note.

On Monday, China let its yuan currency weaken past the key 7-per-dollar level to its lowest in over a decade, a surprising move that rattled global markets and prompting Washington to label Beijing a currency manipulator.

China’s yuan has now weakened just over 2.5% against the U.S. dollar since the start of the year. ANZ estimates that has contributed 1.0 percentage point to the PPI in the first half of 2019, and said a boost of similar magnitude can be expected if the exchange rate against the dollar stays at 7.1.

“China now has another lever to combat deflationary risks because the exchange rate is allowed to be more market-determined,” ANZ said.

CONSUMER INFLATION PICKING UP

Friday’s data also showed China’s consumer inflation picked up to a 17-month high in July, mainly driven by a jump in prices of pork and other proteins due to a prolonged outbreak of African swine fever, and dry weather in fruit-growing regions.

The consumer price index (CPI) rose 2.8% from a year earlier, a touch higher than expectations and June.

Food inflation accelerated at the fastest pace since January 2012. The food price index rose 9.1% on year, picking up from a 8.3% uptick in June. Fruit prices surged 39.1% and pork prices jumped 18.2%.

On a month-on-month basis, CPI grew 0.4% in July after dipping 0.1% in June.

Core consumer inflation -- excluding food and fuel -- remained modest, however, easing marginally to 1.3% on-year.

“The upshot is that China faces the worse of both worlds,” said Capital Economics in a note.

“Accelerating consumer prices will weigh on household confidence and real income growth, but at the same time, the return of factory-gate deflation that will put further downward pressure on manufacturing profits.”