September 25, 2023

China’s surprise interest rate cut fuels expectations of more easing

(Bloomberg) — China’s central bank surprised most economists and market participants by cutting short-term interest rates, a sign that officials are increasingly concerned about faltering growth and are ramping up stimulus to boost the recovery.

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The People’s Bank of China cut its seven-day reverse repo rate by 10 basis points to 1.9% on Tuesday, its first rate cut since August 2022. That increases the likelihood that the central bank will cut its one-year lending rate on Thursday. , with banks expected to lower their interest rates soon after.

Tuesday’s move underscores heightened concerns about a growth slowdown: Recent economic indicators showed that inflation remained near zero in May, manufacturing activity contracted and an early rebound in the real estate market fizzled. Speculation is mounting that the PBOC may cut rates even further this year, as Beijing considers a broad stimulus package.

“Policymakers are finally acknowledging the economic weakness,” said Michelle Lam, Greater China economist at Societe Generale SA. “In the second half of 2023, there should be more cuts to interest rates and the required reserve ratio.”

Economists from Goldman Sachs Group Inc. forecast a 25 basis point reduction in lenders’ reserve requirements – freeing up more money for banks to boost lending – in the third quarter. Another reduction in the ratio or policy rate could occur in the fourth quarter, depending on the performance of the economy, they wrote in a research note on Tuesday.

Macquarie Group Ltd. expects a 10 basis point cut in one-year medium-term lending rates in the third quarter, following a cut later this week.

Muted response

A gauge of Hong Kong-listed Chinese stocks rose 0.4% during the midday break, boosted by technology stocks. Real estate stocks – which rose immediately after the cut – cut more of the gains, with a developer gauge rising just 0.3%.

While interest rate cuts may help sentiment in the short term, economists say more needs to be done to boost corporate confidence to invest. Demand for loans remains weak, and rapid money growth alongside sluggish private investment means that monetary easing alone will not do much to stimulate the economy.

“An interest rate cut is not enough to boost the market,” said Steven Leung, executive director of UOB Kay Hian. “The market needs more policy support, both monetary and fiscal, before bearish sentiment about China’s economic outlook turns.”

The timing of Tuesday’s move suggests that the PBOC may be trying to “lead the way” and the upcoming US Federal Reserve policy meeting “to soften the impact of the rate cut on the yuan,” said Ken Cheung, head of Asian FX strategist at Mizuho Bank Ltd in Hong Kong. Economists expect the Fed to finally break its aggressive rate hike cycle this week.

A grip from the Fed could lessen the impact PBOC easing measures have on capital outflows and the yuan, which has weakened 3.6% against the dollar this year and is one of the worst-performing Asian currencies.

The offshore yuan weakened to a six-month low on Tuesday after the near-term policy rate cut, approaching the closely watched level of 7.2 per US dollar. The yield on 10-year government bonds fell five basis points to 2.62% just before noon local time, the lowest level since September.

Loan Rates

Tuesday’s rate cut came as a surprise, as the PBOC rarely shifts short-term rates ahead of one-year rates. The last time that happened was in March 2020.

Policy rate cuts pave the way for a cut in loan prime rates when de facto benchmark interest rates are announced next week, economists say. The LPRs are based on the interest rates 18 banks offer their best clients, and usually move in tandem with the MLF rate.

Authorities recently guided major banks to lower their deposit rates, which could help them preserve margins and cope with lower lending rates.

What Bloomberg’s economists say…

“The People’s Bank of China’s decision to cut its 7-day reverse repo rate by 10 basis points is a clear sign that it will make an equivalent cut to its medium-term credit facility – the key interest rate – on June 15. The PBOC usually adjusts at the same time as the tool. Moving earlier on the repo rate is significant. We think it shows that the central bank wanted to provide early guidance and reassure the market of its accommodative stance given the weakness of the post-Covid recovery of the economy.”

– David Qu, economist

Read the full report here.

PBOC Governor Yi Gang pledged last week to ramp up “counter-cyclical adjustments,” a shift in language that some analysts say meant more easing. He also pledged to “make every effort to support the real economy” as the recovery in demand lags behind that in supply.

Beijing has taken a measured approach to monetary and fiscal stimulus this year, favoring targeted measures that boost specific sectors of the economy that need help, such as small businesses. Officials in recent weeks outlined incentives to boost consumption of electric cars and other types of vehicles, while the government is also considering a support package for the property market, according to people familiar with the matter.

In addition to industrial production, retail sales and investment data to be released Thursday, other indicators may also be gloomy this week.

“The May credit data released today or tomorrow could be very bad,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd., referring to expected credit and new loan numbers. “The PBOC may be concerned about the potential shocks to the market and so has taken the opportunity to address concerns beforehand.”

–With help from Tian Chen, Ishika Mookerjee, Chester Yung and Charlotte Yang.

(Updates with the latest predictions from Goldman Sachs.)

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