Today’s data on China’s GDP growth beat expectations, and monthly growth in industry picked up again recently , suggesting that the policy easing measures taken since late last year are starting to have an effect.

GDP growth in Q2 was held back by continued weakness in investment. Meanwhile, export momentum slowed but private consumption held up better. In the housing market, sales growth remained brisk in June. However, amid still high inventories of unsold housing, housing construction is not yet benefiting from the better sales growth. On the other hand, infrastructure investment benefits from its key role in the government’s policy efforts to support growth.

Downward pressures on growth stemming from the weakness in industry amidst the property downturn are dampened by the robust expansion of the service sector. Value added in the tertiary sector significantly outgrew that in the secondary sector in the first half of 2015, especially in nominal terms, due to large differences in pricing power. With employment in industry not growing anymore, job creation in the still robustly expanding service sector is critical in supporting urban job growth and migration.

The still reasonably healthy urban job market supports continued solid growth of wages and consumption. However, a significant slowing of passenger car sales in recent months points to a risk that consumer confidence may be affected by the lingering weakness in industry. Going forward, the stock market turmoil may also affect consumption somewhat.

The strong showing of the service sector is largely necessary and sustainable. The combination of weak growth in industry, solid expansion in services and a relentless change in the relative price in favor of services is key to the rebalancing of China’s economy.

However, since mid-2014 the service sector received a significant boost from the stock market rally and the associated activity, which was much less sustainable. We expect that the sharp correction of the stock market rally will have considerable effect on the turnover in the financial sector, which could shave around 0.2 ppt or so off GDP growth in Q3. Indeed, this may be the most significant channel via which the stock market turmoil impacts the real economy – more significant than wealth effects.

Export momentum was subdued in Q2 but is not as weak as the official data suggests, in our view, while it picked up a bit in June. Meanwhile, according to RBS estimates, the momentum of “normal” imports – used in China’s own economy – improved significantly in June, supporting the impression that domestic demand momentum improved in June.