China's manufacturers are facing intensifying cost pressures, with fuel processing costs surging 35% and the prices producers charge climbing at their fastest pace since June 2022 amid the war in Iran.

China's producer price index — which tracks the prices factories receive for their goods before they reach store shelves — rose 5.7% from a year earlier in October, according to data from the National Bureau of Statistics released on Monday. The reading exceeded the 5.3% economists expected in a Reuters poll and accelerated from 5.0% in September, marking the third straight month of faster producer inflation. The last higher annual reading was 6.1%, recorded in June 2022, according to LSEG data. Because factory-gate costs tend to show pricing pressure before it reaches shoppers, the wide gap with consumer prices shows how much of the cost burden companies are absorbing themselves.

Factories pay more, but shoppers aren't picking up the bill

Mining and raw materials saw the biggest price increases. With the Middle East conflict keeping oil and gas expensive, coal miners, natural gas producers, petroleum processors, and chemical companies are all confronting heavier operating expenses. Energy-intensive factories are feeling the same squeeze, and production costs are rising across the board.

Ordinarily, businesses would try to recover those costs by charging buyers more. The problem is that Chinese households are still watching their spending, so price hikes could cost companies sales. The result is that factory inflation is racing ahead while store prices barely move. The wider the gap between what factories pay and what shoppers pay, the more of the cost increase companies have to absorb rather than pass on.

The consumer price index rose by only 0.7% year on year in October, compared with a rise of 0.9% in September and below economists' estimate of 0.8%. Core CPI, which removes food and energy prices, fell to 0.8% from 1.0%. Upcoming monthly releases will show whether the streak of accelerating factory-gate inflation extends beyond October.

Some encouraging figures have emerged in other readings. China's economic growth came in at 4.6% in the third quarter, compared with analysts' expectations, and September retail sales also came in stronger than forecast. But exports cannot fix weak domestic spending, and foreign demand can turn suddenly if trading partners impose new restrictions or overseas buyers cut their orders. Official data show that external shocks are having a growing effect on the economy and that the mismatch between strong supply and weak domestic demand remains serious.

The stock market presents another concern, as AI stocks are crashing amid investor doubts about demand and the weighing of export restrictions targeting Chinese technology. Those losses could hurt confidence, and government market support has yet to restore it. Still, the CSI 300 rose 0.56% after Monday's inflation figures were released.

Banks fight the yuan's rise as carmakers look beyond China

China's exporters face another costly problem: the yuan has appreciated, cutting into their already slim profit margins on products sold abroad. Efforts have been made to curb the currency's rise, and banks are now providing another incentive to keep dollars instead of converting them into local currency.

According to bankers, more than six banks — including state-owned, joint-stock, and foreign lenders — have increased dollar deposit rates in recent weeks. Some of these dollar deposit rates exceed those offered in the US, hitting levels not seen since at least 2023.

The country's automakers illustrate just how much businesses are leaning on foreign customers. Passenger vehicle exports reached 932,000 units in October, a 68.2% increase from a year earlier, according to the China Passenger Car Association. September exports totaled 923,000, up 73.2% annually — exports are still growing rapidly, even though the pace has cooled.

Back home, the picture is very different. Domestic passenger car sales plunged 27.3% to 1.65 million units in October. That was slightly less severe than September's 28.1% drop, but it marked the 12th consecutive month of declines. Carmakers can sell more abroad, yet the crowded home market keeps putting pressure on prices and profits.

BYD's global sales were slower in October, and third-quarter profit growth failed to meet forecasts as competition heated up both in China and outside of it. BYD is also moving to cater to richer customers: its Yangwang luxury sedan made an international debut in Dubai on Friday.

It is getting easier to see who the winners and losers are. Record October sales were recorded by Leapmotor (9863.HK), Xpeng (9868.HK), and Xiaomi (1810.HK). By contrast, deliveries have dropped at the car brands under Huawei's Harmony Intelligent Mobility Alliance, as well as at Li Auto (2015.HK) and Nio (9866.HK).

Following this year's disappointing decline, the domestic automobile market will experience only modest growth in 2027.