The spot iron ore price jumped back to US$60.74 a tonne on Friday, a rise of 2.1%, after reports suggested that China was struggling to cut back its steel overcapacity and stronger measures would be needed.

According to analysts from Metal Bulletin, “China has achieved only 47% of its targeted crude steel capacity cuts of 45 million tpy (tonnes per year) for 2016 during the January-July period, which means its progress is not going as planned, state newspaper People’s Daily reported on Friday.

The slow and uneven progress across the country has led an inter-ministerial joint inspection team — formed earlier this year to address overcapacity in the steel and coal industries — to plan spot checks around the country starting in the middle of August.

It seems that the market views that news as bullish for steel prices – if supply is reduced, that’s usually good news for steel prices and consequently iron ore.

China has been trying to cut its steel capacity due to weakening demand for the product and overwhelming supply. Western nations and the European Union have also applied pressure to China’s leaders to cut steel supply to offer some protection for their domestic steel industries.

The collapse of steel maker and iron ore miner Arrium Ltd (ASX: ARI) could partly be attributed to a wave of cheap imported Chinese steel.

However, higher steel prices and reduced capacity could also mean less demand for iron ore and coal.

Should China manage to achieve its steel capacity reductions, it will almost certainly mean less demand for iron ore – and that spells bad news for higher cost iron ore miners like Atlas Iron Limited (ASX: AGO) and BC Iron Limited (ASX: BCI).

Foolish takeaway

The light at the end of the tunnel could be that cuts to Chinese steel capacity could also see a significant reduction in higher cost, lower quality Chinese iron ore production. That would be good news for Australia’s iron ore miners – which tend to produce higher quality iron ore.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.