China retail sales post first drop since Covid as economy diverges

China's consumer spending fell for the first time in more than three years, deepening a two-speed economy where export-driven factories boom while households and property remain in the doldrums.

China's retail sales dropped 0.6% in May from a year earlier, the first decline since the end of Covid lockdowns in December 2022, as a property slump and weak household demand widened the gap with export-driven factory output.

"The domestic imbalance between strong supply and weak demand is acute," the National Bureau of Statistics said in a statement accompanying the data, calling for greater employment support and development of new technologies.

Fixed-asset investment shrank 4.1% in the first five months from a year earlier, deepening from a 1.6% drop in January-April and missing the 2% decline forecast by economists in a Reuters poll. Real estate investment plunged 16.2%, while manufacturing investment contracted for the first time since December 2020, according to Wind data. Infrastructure investment eked out 0.6% growth. Industrial output rose 4.5% in May, beating estimates of 4.3%, buoyed by a nearly 20% surge in exports.

The divergence — dubbed "two-speed" or "K-shaped" growth by economists — leaves Beijing unlikely to unleash major stimulus despite the consumer weakness, as the economy remains on track to meet its 4.5% to 5% GDP growth target for 2026. But the widening trade surplus has stirred geopolitical tensions, including a brewing trade conflict with Europe.

The consumer weakness was broad-based. Auto sales extended their decline into an eighth consecutive month in May, underscoring softening demand in the world's largest auto market. A government subsidy program that boosted sales of home appliances and electric vehicles last year is widely believed to have pulled forward purchases that might otherwise have occurred this year, leaving a void in demand. Services consumption grew 5.4% in the first five months, slowing from 5.6% in January-April, as per capita spending during the Labor Day holiday lagged behind the same period in 2025.

Inflation data underscored the demand shortfall. The producer price index jumped 3.9% in May from a year earlier, the fastest pace in nearly four years, driven by Middle East conflict-related commodity cost surges. But the consumer price index rose just 1.2%, suggesting Chinese companies are struggling to pass on higher input costs to cautious households.

The property market, a traditional pillar of household wealth, continued to drag. New home prices fell at a faster pace in May, and property sales and new construction also declined more sharply. Weak household loan data released last week suggested people remain wary of borrowing to buy homes amid sluggish income growth and job insecurity. The national urban unemployment rate eased to 5.1% in May from 5.2% in April, though about 12.7 million graduates are entering the job market this summer.

High-tech manufacturing output rose 15.1% in May, reflecting China's push into AI and renewable energy production. The country's exports have surged nearly 20% in dollar terms, boosted by overseas demand for artificial intelligence and renewable energy products, helping offset the drag from the Iran conflict on energy costs.

Morgan Stanley said the path to consumption recovery may be "gradual and bumpy," with its latest consumer survey showing only slight improvement in sentiment. The broker highlighted Mengniu Dairy, Yili, Haidilao, China Resources Beer, Giant Biogene and Chagee Holdings as stocks to watch for a potential turnaround.

"The export boom can help to mitigate the weak domestic demand in the short term. But given the size of China's economy, strong export growth will likely lead to tension with trading partners," said Zhiwei Zhang, chief economist at Pinpoint Asset Management, adding that a potential trade conflict with Europe is a risk to watch in the coming months.

The last time China's retail sales posted a year-over-year decline was in December 2022, when the country was still under strict zero-Covid restrictions. The subsequent reopening drove a brief consumption rebound that has since faded as the property downturn deepened and household confidence eroded. Economists expect second-quarter GDP growth to slow to around 4.5% from 5% in the first quarter, with policy fine-tuning possible after the data is released in July.

This article is for informational purposes only and does not constitute investment advice.