The wrong kind of inflation: How the Iran war ended China’s deflation cycle

For years, China has been battling deflation. 

• But as of last month, it faces the opposite problem – a shift that couldn’t have come at a worse time.

The Iran war has delivered an energy price shock that has rippled through China’s economy at rapid speed. 

• The US-Israel strikes on Iran began on February 28 – by March, PMI survey data was already pointing to the fastest rise in input costs in four years.

And this week, the stats bureau confirmed it: China’s deflationary cycle has come to a sudden end – just not in the way Beijing had hoped.

Throughout March:

• Producer prices (PPI) grew 0.5% y/y – the first year-on-year increase in over three years
• On a month-on-month basis, PPI for the oil and gas extraction subsector surged 15.8%
• China’s purchasing price index – which measures manufacturers’ input costs – rose 0.8% y/y, the first increase since 2023

The energy shock is feeding through to consumers, too. 

• Transportation fuel costs rose 10.0% month-on-month throughout March. 
• Major Chinese airlines hiked domestic fuel surcharges sixfold.

But here’s the catch: This is the wrong kind of inflation.

• Cost-push inflation – driven by a supply shock rather than strengthening demand – does not solve China’s deflation problem in the way demand-pull inflation would. 
• It compresses margins rather than expanding them, and squeezes household disposable income without improving consumer confidence or the propensity to spend. 

To Beijing’s credit, policymakers have pulled out all the stops to cushion the blow.

• Throughout Jan-Feb, China pre-emptively boosted crude oil imports nearly 16% y/y, adding to strategic reserves that provide 3-4 months of import cover. 
• Beijing has also restricted fuel exports to preserve domestic availability. 
• Meanwhile, the macro planner (NDRC) has intervened multiple times in its standard fuel price adjustment cycle, capping retail gasoline and diesel price increases at roughly half the level that would normally apply – a rare measure not seen since 2013.

And yet, the squeeze is still coming through. 

• Reporters visiting home appliance stores across Shanghai found staff at consumer electronics company TCL warning that TV prices are set to increase 8%, while staff at home appliance manufacturer Midea said refrigerator prices could rise by “several thousand yuan.”
• Staff at other brands echoed similar expectations.

The risk now is that cost-push inflation hits consumption precisely when Beijing has less room to respond. 

• With consumer goods trade-in subsidies already trimmed this year and interest rate cuts on hold until at least H2, the government’s ability to offset the squeeze on household purchasing power is more limited than it was a year ago.

The irony is that Beijing entered 2026 hoping to engineer a gradual reflation through demand-led mechanisms – trade-in subsidies, services consumption, and recovering business confidence. 

• What it has received instead is a cost shock disproportionately concentrated in input prices.

The upshot: The deflationary era in China may be over. 

• But what’s replacing it won’t feel like good news to most Chinese households – or to the businesses that serve them.

Joe Peissel, Senior Macroeconomic Analyst, Trivium China