(Bloomberg) —

China’s economy steadied for a second month, a sign that the post-pandemic recovery is in a more stable phase and that growth is slowly rebalancing toward the consumer..

The recovery from the pandemic has been led by a property-fueled construction boom and surging industrial production for export, with consumer spending remaining the weak link — and the key to more sustainable growth. The latest data released Wednesday by the statistics bureau showed a shift toward consumption-driven demand is underway, but at a gradual pace.

Industrial production rose 6.6% in May on a two-year average basis — which strips out the impact of last year’s pandemic — while retail sales grew 4.5%, about half of its pre-pandemic rate. Investment in fixed assets such as property and land was 4.2% on that basis in the five months through May, according to the National Bureau of Statistics. All of the figures were roughly in line with the previous month, suggesting the economy’s growth has stabilized.

“Robust industrial production is mostly driven by external demand, while domestic demand still hasn’t recovered to pre-pandemic levels,” said Ding Shuang, chief economist for Greater China at Standard Chartered Plc. “Policy makers will be more cautious with the pace of policy normalization.”

He expects the People’s Bank of China to inject liquidity to ease upward pressure on interest rates, adding that the slowdown in credit growth likely peaked in May.

The relative economic stability means Beijing will continue to deepen efforts to clamp down on economic risks — from opaque investments sold by banks, surging property prices in some regions and spiking producer price inflation — rather than adding stimulus to boost growth.

Earlier Wednesday, the government said it will release state stockpiles of metals like copper and aluminum. State-owned enterprises have also been ordered to limit their exposure to overseas commodities markets, according to people with knowledge of the matter.

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Consumers are still cautious despite coronavirus outbreaks being largely under control for a year and the government on course to deliver 1 billion vaccines by the end of the week. Spending during a national holiday this past weekend was 25% lower than pre-pandemic levels, according to government data.

“The consumption recovery has not been as strong as people have been hoping for,” said Michelle Lam, Greater China economist at Societe Generale SA. A recent outbreak of coronavirus in the Chinese manufacturing heartland of Guangdong has been quickly suppressed but continues to interrupt exports from the province, which “adds further risk to the recovery,” she said.

K-Shaped Recovery

High-end consumption is still out-performing more mainstream goods, suggesting the effects of a K-shaped employment recovery in China. Jewelry sales surged 31.5% year-on-year in May from a low base, while everyday categories such as food and clothing saw more modest rises. A slight fall in the unemployment rate to 5%, the lowest level since May 2019, should improve sentiment for workers.

There was a slight uptick in retail sales in May from the previous month when measured on a two-year basis and NBS spokesman Fu Linghui told reporters that “economic growth is gradually returning to the normal state of being driven by domestic consumption.”

What Bloomberg Economics Says…

China’s May activity wasn’t as weak as the year-on-year readings indicate. Yes, they all undershot expectations. Compared with April, though, the two-year compound growth rates for fixed asset investment and retail sales picked up. The pace of production slowed — driving home the message that the economy is past its rapid-recovery stage.

David Qu, China economist

For the full report, click here.

China’s stock trading closed just as the data were released. The CSI 300 Index fell 1.7% on Wednesday, the most in two months, with health care, information technology and materials sub-gauges all losing 3%.

The crackdown on commodity prices hasn’t yet dented the economy. Mining output in May rebounded from the previous month, while steel production at 99.5 million tons was a monthly record as Beijing urged producers to increase production to curb inflationary pressure.

There appeared to be some progress on a key issue facing China’s economy this year: whether there will be a shift in investment away from the property market — which carries bubble risks — toward manufacturing. Manufacturing investment was up 0.6% in January-May on a two-year growth basis, the first time it has turned positive this year. Private sector investment also significantly outpaced investment by state-owned companies.

“Property investment is expected to continue to slowly lose momentum due to tightened financing rules for both property developers and home buyers,” economists at HSBC Holdings Plc said in a note.

Port Disruptions

In the manufacturing sector, pharmaceuticals production surged 34% year-on-year, likely due to China’s rapid vaccine roll-out. Automobile production fell from the previous month as companies grappled with a chip shortage and a recent weakening in domestic sales.

Looking ahead, there are risks to the manufacturing performance. China is experiencing power shortages in some areas because of surging electricity consumption and drought in the south. The Guangdong outbreak has halted some port operations and limited the movement of people, and it’ll likely continue to affect the economy through June, according to Iris Pang, Greater China chief economist at ING Bank NV in Hong Kong.

Another downside to growth in the short term is Beijing’s increased focus on risks in its financial system. Beijing is taking aim at more than $1 trillion of opaque investments sold by banks, which should help the economy in the long-run but could also starve property developers and less credit-worthy borrowers of funds for investment. That is adding to elevated credit risks for companies.

Economists expect the economy to gradually moderate this year from 8% in the second quarter to 6.2% in the third quarter and 5% by the final three months of the year. Growth is still expected to reach 8.5% for the full year, easily topping the government’s target of ‘above 6%.’

(Updates with additional details, comment from economist.)

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