(Bloomberg) -- China’s deflation was driven by falling prices in its manufacturing sector last year, fresh data showed on Thursday, adding to the risk of trade tensions with the US and Europe amid a major ramp-up in Chinese industrial capacity.

China’s GDP deflator, the widest measure of prices across the economy, fell 0.6% in 2023, the steepest annual decline since the late 1990s, according to Bloomberg calculations based on data from China’s statistics bureau. Among sectors, manufacturing showed the biggest price drop, at 3.2%, Bloomberg calculations show.

The figures add to evidence that domestic supply in some sectors is running ahead of China’s demand. And that’s likely to fuel accusations in Washington and Brussels that China is over-investing in some manufactured goods sectors, undermining US and European Union rivals.

Agricultural prices dropped 2.2%, Thursday’s figures showed, based on Bloomberg calculations. But it’s manufacturing deflation that’s raising tensions. An index of China’s export prices fell 9.2% year-on-year in November. And China clocked a trade surplus of some $823 billion for all of last year, the second highest on record.

While consumers round the world may benefit from China’s cheapening goods prices — and many central banks may appreciate the disinflationary impulse — for overseas producers the impulse threatens their own competitiveness. Politicians may see China’s deflation as a threat to jobs in their constituencies, and to investment programs aimed at bolstering the transition to electric vehicles and renewable energy.

“China has the best supply chains when it comes to EV cars or renewables. Coupled with weak domestic demand, the downside of this is that this has led to overcapacities and a collapse of prices,” the EU ambassador to China, Jorge Toledo, said at an event this week. “The threat is that China will be flooding the market at incredible prices — and this will put our industries at risk.”

China’s investment in manufacturing grew 6.5% in 2023, according to official data. The industrial capacity utilization rate increased slightly in year-on-year terms to 75.9% in the last quarter, close to a pre-pandemic rate of 77.5%.

One area of the economy that did see inflation last year was services - which helped push the share of that sector to a record 54.6% of China’s GDP. Manufacturing’s share of output fell slightly to 26.2%, reflecting the drop in output prices.

Prices in China’s contracting real estate sector were positive for the year. “However, it is important to note that real estate in the tertiary sector does not include construction activity, which is captured by the construction deflator that dipped to -1.0% in 2023,” economists at Nomura Holdings Inc. led by Harrington Zhang wrote in a note.

Deflation could linger in 2024 due to weak food prices and PPI deflation, the Nomura team wrote. “The implied GDP deflator could even record another negative reading for full-year 2024.”

As for food prices, they should stabilize as demand recovers and government policies supporting agriculture take effect, Jin Xiandong, an official with the country’s top economic planning agency, said in a briefing on Thursday.

--With assistance from Michael Nienaber.

©2024 Bloomberg L.P.