LONDON: The flurry of data out of China this morning confirmed what everyone already knew.

The engine of global industrial production has shifted down a couple of gears. Headline GDP of 7.6 percent in the second quarter marked the slowest rate of growth in more than three years.

It's not good news for industrial metals, given that China has been the key driver of usage growth since the Great Contraction in 2008-2009.

But it is news that has already been factored in to commodities such as copper.

It is why London Metal Exchange copper prices sank to fresh 2012 lows in June and have struggled to make much headway since.

But not all industrial metal prices have been so hard hit. Benchmark iron ore is this morning quoted at $133.70 per ton, little changed from the start of the year, according to The Steel Index.

Such a price level is still sufficiently high to incentivize even the highest-cost of China's own iron ore producers, who fill the gap between what the external market can supply and what China's steel industry requires.

Iron ore's relative price resilience over the last couple of months reflects what is happening in China's steel sector.

Amid a broad-based slowing of industrial activity China's mills are still pumping steel out at almost record rates.

Average production in June of 2.007 million tons was the second highest ever after April's 2.019 million tons.

STAND-OUT STEEL

How to explain the steel sector's stand-out performance relative to just about every other industrial indicator in China?

Is there a fundamental underpinning of such divergence?

There are steel-specific bright spots within China such as the automotive sector.

Vehicle sales rose 9.9 percent in June from a year-earlier, according to the China Association of Automotive Manufacturers.

That represented a pronounced pick-up from sluggish sales figures in the first part of the year, June's performance helping to drag the first-half growth figure up to 2.9 percent.

But even China's giant automotive industry is dwarfed by the construction sector, the single biggest driver of steel demand in China.

And here there is still no evidence of any turnaround.

Property investment growth slowed to 16.6 percent in the first half of 2012 from 32.9 percent growth in the first half of 2011.

Even more tellingly, newly-started property construction slumped 16.3 percent in June from a year earlier, deepening the downtrend after a 4.6-percent slide in May.

This sharp contraction in activity is part and parcel of Beijing's micro-management of what was in danger of becoming a full-blown urban property bubble.

It is also part and parcel of the broader economic slowdown story. The property market accounted for 13 percent of gross domestic product in 2011.

Some offset comes from the government's continued drive to encourage affordable housing in Chinese cities but it is only a cushion not a trend-changer.

A DANGEROUS DISCONNECT

The disconnect between steel production and the single-biggest consumer of steel in China is creating growing pricing tensions.

On the Shanghai Futures Exchange steel rebar futures dropped another 3.3 percent this week, the steepest loss since mid-May.

Rebar is a steel product used primarily in construction and the sinking price is another manifestation of the property sector slump.

But it is not just rebar.

China's biggest listed steelmaker, Baoshan Iron & Steel, has just cut prices on hot-rolled and cold-rolled steel, products more leveraged to general manufacturing than construction.

The company is regarded as a bellwether for the country's steel pricing so more producer price cuts look inevitable.

China's mills, however, are evidently ignoring such price signals and holding collective run-rates at near record levels in an attempt to grab domestic market share.

By doing so they are both supporting the price of iron ore and compressing their own margins in what risks becoming a vicious circle.

A further harmful by-product of this yawning disconnect is the surge in Chinese steel product exports, up 12.1 percent in the first half of the year.

The accelerated export flow is generating increasing numbers of complaints from other countries.

India has just joined the lengthening list of countries preparing possible trade action against China because of alleged predatory steel pricing.

India is specifically investigating a flood of Chinese stainless steel imports, according to documents lodged with the World Trade Organization.

Steel exports, meanwhile, are already a main source of trade friction between China and the US.

CLOSING THE GAP?

There is a consensus that the disconnect must end.

Since there is little expectation for domestic steel prices to recover any time soon, the logical inference is that iron ore prices are overdue a catch-up downwards readjustment. But for that to happen requires a collective trimming of steel output and therefore iron ore demand.

Some sort of slowdown in steel production over China's summer months is a "normal" seasonal phenomenon.

And the higher-frequency data from China's Iron and Steel Association suggest some slippage in output rates over the course of June.

It is, though, still a highly marginal one with annualized production still booming above the 700-million ton level.

As yet there is no sign of a more fundamental realignment of domestic production and domestic demand.

At some stage China's carefully-targeted boosts to economic activity such as appliance subsidies and social housing will take up some of the steel slack.

But realistically the impact is unlikely to be tangible before the fourth quarter of 2012.

Beijing, meanwhile, shows no inclination of loosening its grip on the commercial property market, which will therefore remain the point of maximum weakness in the domestic steel market.

And until it does, the current domestic pricing tensions, and the political tensions created by ever-rising Chinese exports, look set to grow worse.

— Andy Home is a Reuters columnist. The opinions expressed are his own.