China’s producer prices returned to growth in March for the first time in more than three years, marking a potentially significant turning point for the world’s second-largest economy as surging oil prices from the Middle East conflict begin feeding through to industrial costs.

Official data released Friday by the National Bureau of Statistics showed the producer price index (PPI) rose 0.5% year on year in March, beating economists’ expectations for a 0.4% gain and ending a 41-month streak of factory-gate deflation, the longest such run in decades.

The move into positive territory is being driven less by a broad-based recovery in domestic demand than by a sharp rise in imported energy and commodity costs, as the war involving Iran and the disruption to shipping through the Strait of Hormuz continue to roil global markets.

By contrast, inflation at the consumer level remained comparatively subdued. China’s consumer price index (CPI) rose 1.0% in March from a year earlier, slowing from 1.3% in February and missing the 1.2% consensus forecast in a Reuters poll. On a monthly basis, CPI fell 0.7%, a much steeper decline than the expected 0.2% drop, suggesting that underlying consumer demand remains soft even as upstream price pressures intensify.

That divergence between producer and consumer inflation is the most important signal in the data as it points to what economists often describe as cost-push inflation, where rising input costs, rather than stronger household demand, drive price increases.

This is the kind of inflation policymakers dislike most because it squeezes manufacturers’ margins while offering little evidence of stronger economic momentum.

The immediate catalyst is energy. The Middle East conflict, now in its sixth week, has sharply disrupted global oil flows after Iran effectively shut the Strait of Hormuz to most commercial tankers and regional producers curbed output. Brent crude has surged dramatically since the crisis began, with benchmark prices moving close to the $100-per-barrel mark and, at points, even higher across different sessions.

Although China has boasted of sufficient energy, as the world’s largest crude importer, the Iran war has created an imported inflation shock.

Senior NBS statistician Dong Lijuan explicitly linked the rise in factory-gate prices to the surge in global commodity and energy costs caused by the conflict, saying imported inflation had pushed up prices across multiple industrial sectors.

Morgan Stanley’s chief China economist Robin Xing said the country is still relatively better positioned than many peers.

“China fares better than its peers amid a sizable yet not extreme oil shock, given its energy fungibility and policy flexibility with low starting inflation,” Xing said.

That assessment rests on several structural cushions. China has extensive strategic petroleum reserves, diversified energy import routes, and a rapidly expanding renewable energy base that helps soften the pass-through from imported oil shocks. But it has failed to completely shield it from the mounting macro risks. Morgan Stanley has cut its 2026 China GDP growth forecast by 10 basis points to 4.7%, assuming oil averages $110 per barrel in the second quarter.

The downside scenario is more concerning. Should oil prices remain above $150 per barrel through the quarter, the bank estimates China’s growth could slow to 4.2%, a meaningful deceleration for an economy already contending with weak property activity, uneven consumer confidence, and external trade uncertainty.

Against the energy backdrop, a major policy dilemma is now emerging for Beijing. Headline inflation remains below the 2% level generally considered consistent with healthy domestic demand, which in normal circumstances would leave room for monetary easing. But the return of producer inflation complicates that calculus.

Global banks have already begun scaling back expectations for interest-rate cuts, with several now expecting the People’s Bank of China to keep benchmark rates unchanged this year as the oil shock clouds the inflation outlook. That means policymakers are increasingly caught between supporting growth and containing imported inflation.

Beijing has already started intervening at the retail fuel level. Earlier this week, China’s top economic planner, the National Development and Reform Commission, raised gasoline and diesel prices by 420 yuan and 400 yuan per metric ton, respectively, while deliberately keeping the increase below what the automatic pricing mechanism would normally require.

This follows even larger hikes last month. The strategy is to cushion households from the full shock while allowing some pass-through to industrial users. Yet that buffering itself may intensify margin pressure on manufacturers.

Economists are warning of what Tianchen Xu at the Economist Intelligence Unit described as “bad inflation”.

This is inflation driven by rising costs rather than rising demand, and it can be particularly painful for industrial firms already operating on thin margins.

The warning signs are visible in the data as the purchasing price index for raw materials, fuel, and power rose 0.8% year on year, outpacing the 0.5% increase in PPI. That means input costs are rising faster than the prices manufacturers are able to charge for finished goods.

Practically, factories are absorbing part of the shock. This threatens to erode the profit gains industrial firms recorded earlier in the year, when Beijing’s efforts to curb overcapacity and rein in price wars had briefly improved margins.

The March data is therefore telling two stories at once. On the surface, the end of a 41-month deflation streak may appear to signal improving industrial conditions. In reality, the inflation impulse is being driven externally by oil and commodity costs, not internally by stronger demand.

But a positive PPI driven by imported energy shocks is not necessarily evidence of economic recovery. Instead, it may signal the beginning of a more difficult phase for China’s economy, one in which growth slows even as inflationary pressures rise. In other words, policymakers may be facing an early form of stagflation risk.

The coming quarter will be critical as it will depend largely on whether oil markets stabilize and whether the Strait of Hormuz disruption eases. If not, analysts warn that China’s brief escape from deflation could quickly turn into a broader cost-push inflation cycle that weighs on both industry and growth.