China’s surprise rate cut fuels expectations of further easing

(Bloomberg) – China's central bank surprised most economists and market participants by cutting its short-term interest rate. This is a sign officials are growing concerned about flagging growth and are stepping up stimulus measures to boost the recovery.

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The People's Bank of China on Tuesday cut the interest rate on seven-day reverse repurchase agreements by 10 basis points to 1.9%, the first rate cut since August 2022. That increases the likelihood that the central bank will cut its interest rate on one-year loans on Thursday, banks are likely to lower their lending rates shortly thereafter.

Tuesday's move underscores growing concerns about a slowdown in growth: Latest economic indicators showed inflation remained near zero in May, manufacturing activity slowed and an early recovery in the housing market stalled. Speculation is mounting that the PBOC could cut rates even more this year as Beijing mulls a broad package of stimulus measures.

“Policymakers are finally acknowledging the economic weakness,” said Michelle Lam, Greater China economist at Société Générale SA. “There should be further interest rate and reserve ratio cuts in the second half of 2023.”

Economists at Goldman Sachs Group Inc. are forecasting a 25 basis point cut in the reserve requirement ratio for lenders in the third quarter – freeing up more money for banks to boost lending. Depending on the economic development, there could be a further reduction in the ratio or key interest rates in the fourth quarter, they wrote in a research note on Tuesday.

The Macquarie Group Ltd. expects a 10 basis point cut in the one-year term borrowing rate in the third quarter after cutting it later this week.

Muted reaction

An indicator for Hong Kong-listed Chinese stocks rose 0.4% during the lunch break, boosted by tech stocks. Property stocks, which rallied immediately after the cut, gave up gains more sharply, with homebuilders up just 0.3%.

While rate cuts could improve sentiment in the near term, economists say more needs to be done to boost business confidence in investing. Credit demand remains weak and fast money supply growth coupled with sluggish private investment means that monetary easing alone will not do much to stimulate the economy.

“A rate cut is not enough to stimulate the market,” said Steven Leung, chief executive of UOB Kay Hian. “The market needs more monetary and fiscal support before dovish sentiment on China's economic outlook turns.”

The timing of Tuesday's move suggests the PBOC may be looking to “get ahead of the curve” and the upcoming Federal Reserve policy meeting “to soften the impact of the rate cut on the yuan,” said Ken Cheung, chief Asian strategist Foreign Exchange at Mizuho Bank Ltd. in Hong Kong. Economists expect the Fed to finally end its aggressive rate-hike cycle this week.

A Fed standstill could mitigate the impact of the PBOC's easing on capital outflows and the yuan, which has weakened 3.6% against the dollar this year and is one of the worst-performing currencies in Asia.

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

lending rates

Tuesday's rate cut came as a surprise as the PBOC rarely adjusts the short-term policy rate ahead of the one-year rate. The last time this happened was in March 2020.

Policy rate cuts pave the way for a cut in policy lending rates when de facto benchmark lending rates are announced next week, economists say. The LPRs are based on the interest rates that 18 banks offer their best customers and they usually move in line with the MLF rate.

Authorities recently ordered big 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 the 7-day reverse repo rate by 10 basis points is a clear sign that it will make a corresponding cut to its medium-term lending facility – the policy rate – on June 15. The PBOC usually adapts to the tools at the same time. It is important to change the repo rate sooner. In our opinion, this shows that the central bank wanted to provide early guidance and reassure the market of its easing policy given the weak economic recovery after the Corona crisis.”

— David Qu, economist

Read the full report here.

PBOC Governor Yi Gang last week vowed to step up “countercyclical adjustments,” a change of language that some analysts say signaled further easing. He also pledged to “make every effort to support the real economy” as the recovery in demand has lagged behind that of supply.

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

Besides industrial production, retail sales and investment data due to be released on Thursday, other indicators could also be gloomy this week.

“The May credit data that could be released today or tomorrow could be very bad,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd., referring to expected numbers on loans and new loans. “The PBOC may be concerned about the potential shocks to the market and so took this opportunity to try to allay concerns upfront.”

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

(Updates with the latest forecasts from Goldman Sachs.)

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