In spite of one more tariff hike since 1H2019, the trade tension appears to be on an improving path compared with 3Q2019. We now see stabilizing export growth as the base case going forward. Since the release of our 2H19 Outlook report[1], the China-US trade talk experienced a few set-backs [2], before landing on a relatively positive note at the time of the report.

On the domestic front, China growth is still faced with a few headwinds. Furthermore, rapidly rising CPI, although purely pushed up by supply side factors, may still pose some soft constraints on policy easing in the next 2-3 quarters. On the other hand, CPI is set to fall quickly and potentially below the “equilibrium” after the “spike”, which may open up the potential for both counter cyclical policy adjustments and asset price performance.

► We expect real GDP growth to decelerate to 5.9% YoY in 2020 & 5.8% YoY in 2021, from 6.1% YoY in 2019. Meanwhile, nominal GDP growth will likely decline to 7.3% YoY & 6.9% YoY in 2020-2021, from 7.9% YoY this year. Our forecast is based on the assumption of a “ceasefire” agreement from the upcoming US-China trade talk[3]. Contingent on our assumption for a relatively “prudent” policy stance until mid-2020, we foresee the “low point” of sequential growth around 3Q2020.

► CPI inflation will likely average at 3.8% in 2020, before sliding to 1.2% in 2021. Headline CPI may stay close to, or higher than, 4% in the next 2-3 quarters. Meanwhile, PPI inflation may fall to -2% in 2020, before climbing back to positive territory towards the end of 2020.

► We now see no more LPR or RRR cuts in the rest of 2019. LPR may be reduced by 40bp in 2H2020 & 30bp in 1H2021. MLF rate is expected to fall as well, albeit by a smaller scale. We see 200bp RRR cut in 2020, most of which back-loaded, followed by another 50bp cut in 1H2021.

► Aggregate central & local gov’t deficit is expected to expand by ~1ppt in 2020, mainly via the expansion of local gov’t special bond issuance quota (by ~1.2 trillion to 3.35 trillion in 2020). Budget deficit will likely be set at 3% in 2020, while the scale of tax cut in 2020 may be limited.

► We see USD/CNY trading at ~7 by mid-2020, and drift towards 7.06 by end-2020. CNY may move in a relatively narrow range vs. the dollar.

Our forecast has balanced the potential upside and downside risks. The risks on both sides lie within the outcome of China-US trade negotiations, as well as macro policy settings in China, and to a lesser extent, the US.

It is possible that the tougher growth and inflation trade-off may prompt the government to use more supply-side measures to boost employment growth, incl. lowering the entry barrier for foreign and private capital in some of the service industries with high growth potential.

[1]See China Macro Thematic Report, Mapping out the downside risks to growth amidst rising uncertainties | China 2H2019 Macro Outlook, published on June 16, 2019.

[2]Effective on September 1, the US imposed 15% tariff on ~40% of the third batch (i.e. the “USD 300 bn list”) of China exports. On October 12, the US postponed the 5ppt tariff hike on US$250bn of Chinese goods that was scheduled to take effect on October 15.

[3]i.e. the 15% hike scheduled on Dec. 15 for the second batch in the 300bn USD list will likely be postponed.

For more details, please see our report External uncertainties eased; domestic demand remains under pressure —— China 2020 Macro Outlook  published in November 2019.